Despite experiencing second and third waves of the COVID-19 pandemic, insolvency and restructuring proceedings in Canada have surprisingly declined. The combination of Federal and provincial emergency support for the economy, and the patience of investors, lenders, landlords and other stakeholders has resulted in a static or declining insolvency filing trend. Notably, proceedings under the Companies’ Creditors Arrangement Act (Canada) (CCAA) are down with only five in the first two quarters of 2021. The number of corporate bankruptcies is also down, being lower than for the same periods in 2020 and 2019. The conventional wisdom is that the government support and relaxing of pandemic-related restrictions are a pre-cursor to a significant recovery.
The caveat to the expected recovery is that the global supply chain crisis continues to put inflationary pressure on large consumer economies around the world. Explosive inflation in logistics costs is putting significant cash flow pressures on Canadian businesses that rely on foreign manufacturing, materials and inputs. This is particularly so for Canadian businesses that source out of China and Asia. The reductions in Chinese steel production caused by power shortages and logistical challenges are a major source of inflationary pressure. Sectors to watch are the automotive manufacturing sector with its heavy reliance on steel and parts from overseas as well as manufacturers of consumer goods being made in Asia and sold through North American retail conduits.
The pandemic’s effects will linger into 2022. Emergency government supports are being withdrawn. Inflation is knocking at the door. Will suppressed growth in corporate and consumer spending overpower these factors to drive the economy back into the black? Will vacancy rates in commercial properties recover? The answers to these questions are not readily available, but it is reasonable to expect an uptick in restructuring, insolvency and bankruptcy filings into the last quarter of 2021 and the first two quarters of 2022 as businesses that have been “running on fumes” succumb to the pandemic-induced capital deprivation before the recovery takes hold.
Will the recovery be soon enough to save the most troubled Canadian businesses? Inevitably, there will be winners and losers but it is possible that many of the most troubled businesses have already been shuttered or sold to investors with deep pockets and patience. There are still significant pools of cash available for any attractive target though not all businesses in trouble will warrant that capital as some will be too far gone.
There are three main insolvency statutes in Canada:
The BIA governs proposals (a restructuring regime for individuals and small to mid-sized companies) (“proposal”), receiverships (“receivership”) and bankruptcies (both personal and corporate) (“bankruptcy”). The CCAA provides a restructuring regime for larger corporations. The WURA is a liquidation statute designed to deal with, among other things, the formal liquidation of certain regulated entities including financial institutions and insurance companies.
There are five main insolvency processes:
There are no express obligations imposed on the directors of a debtor to initiate bankruptcy or restructuring proceedings. However, directors may consider it prudent to commence insolvency proceedings to avoid or minimise statutory liabilities for which the directors may be personally liable by reason of being a director of an insolvent company. Directors may also consider that an insolvency filing is required to avoid any potential claims that the debtor traded while "knowingly insolvent", or that the debtor conducted its affairs in a manner that was oppressive to its stakeholders.
Involuntary proceedings may be commenced by creditors under four of the five insolvency and restructuring regimes summarised in 2.2 Types of Voluntary and Involuntary Restructurings, Reorganisations, Insolvencies and Receivership. Creditors can apply for the appointment of receivers under the BIA or provincial statutes. Creditors with unsecured liquidated claims in excess of CAD1,000 may apply for bankruptcy orders under the BIA where debtors have committed acts of bankruptcy within six months. Creditors can also apply for orders under the CCAA. Involuntary proceedings can be commenced in respect of entities to which WURA applies by:
The BIA defines an insolvent person as a person who is not bankrupt and who resides, carries on business or has property in Canada, whose liabilities to creditors amount to CAD1,000, and:
The restructuring and insolvency regime applicable to banks regulated under Canadian law is governed by both the Bank Act and WURA. Generally, following the exercise of control over a bank by OSFI under the Bank Act, the AG, at the request of OSFI, will seek the appointment of a liquidator and the making of a winding up order under WURA.
Other financial institutions such as credit unions, insurance companies, loan and trust companies and related businesses are subject to WURA and their home statutes (for example, the Insurance Companies Act, the Trust and Loan Companies Act and the Cooperative Credit Associations Act) with respect to substantive or regulatory matters relevant to winding up under WURA.
Part XII of the BIA applies to the insolvency of “securities firms”. These are defined as entities carrying on the business of buying and selling investment instruments on behalf of customers. Part XII provides specific rules applicable to securities firm insolvencies, including rules establishing different funds for the securities held by the firm (the customer name securities fund, customer securities fund and general fund).
Historically, railways have been subject to specific restructuring and insolvency regimes prescribed under their statutes of incorporation, however, in limited circumstances application has been permitted under the CCAA.
The effectiveness of consensual out-of-court workouts and restructuring in Canada varies depending on the specific circumstances and business context of the debtor.
There is a perception that doing as much as possible outside formal proceedings, and doing so consensually, can be preferable and tends to preserve stakeholder value. This is particularly true for businesses whose value is highly dependent on goodwill or reputation (for example businesses operating as intermediaries, brokers or businesses whose customers are dependent upon after-sales support). In certain situations, required regulatory approvals and critical contractual relationships mitigate in favour of out-of-court workouts, to avoid triggers or terminating events affecting these relationships. Finally, where possible, consensual workouts can save transaction costs.
It is common practice for financing parties in Canada to use professional financial advisors to obtain detailed assessments of their borrower’s position and, in appropriate circumstances with contractual protections, to permit time for this to happen. Although not every case is suitable for forbearance arrangements allowing financing parties to develop a highly informed picture of their borrower’s situation, where possible this is preferable.
It is common in Canada for significant out-of-court work to be done on the restructuring or workout of distressed companies but to invoke the authority of the courts to complete this work. This is in contrast to the “file first, figure out later” approach. For example, it is not uncommon to have sale and investment solicitation processes managed outside of and prior to a formal court filing, in a rigorous fashion and based on detailed requirements, but to seek court approval for any resulting sale transactions.
Forbearance agreements are common. Among other things, these agreements permit borrowers to have a contractual breathing space subject to enhanced credit agreement protections and milestones specific to the financial circumstances of the borrower. The terms of these arrangements vary widely and are context specific. Examples include required sale processes for non-core businesses, the solicitation of acceptable subordinate or equity financing and compliance with cash flow projections, financial ratios and reduced financing availability.
Creditor committees may play a role in consensual restructurings but this will depend on how widely debt obligations of a business are held. First lien financings controlled by syndicates governed by their own internal rules and bilateral financings between one financing party and a borrower are common in Canada, making creditor committees less important.
Informational requirements in relation to consensual restructuring are common and often additional to those provided for in existing credit documentation.
Priorities tend to be preserved in relative terms during informal restructurings in Canada. Where realisation analysis makes this obvious, compromises in the amount or terms of debt obligations can be made but this will be entirely dependent upon full disclosure and clear information about the economics of the business. In capital structures featuring significant debt components, equity is always in jeopardy in distressed situations.
Super-priority liens or rights are not common outside a formal process and could only be practically obtained through contractual subordinations or existing registration or possession priorities. Instead, it is common to seek super-priority for new money in a formal filing. A debtor subject to CCAA or proposal proceedings may obtain interim financing, referred to as debtor-in-possession (DIP) financing.
DIP financing must be approved by the court. A supervising court will consider the following factors (among others) in determining whether to grant an order approving DIP financing:
Where an order is granted approving DIP financing, a DIP lender may be granted a corresponding priority charge over the debtor’s property and assets, and in priority over existing secured creditor claims. The special priority granted to a DIP lender may, however, remain subject to other court-ordered priority charges that are granted such as a charge in favour of directors and officers to cover certain director and officer liabilities and a charge to secure payment of the insolvency professionals employed by the debtor, including the debtor’s counsel, the court officer and counsel to the court officer. Existing secured creditors will be notified prior to the court granting an order for DIP financing.
Under the CCAA, where the debtor’s application for interim financing is made at the same time as the initial application for protection under the Act, the court must be satisfied that the terms of the loan are limited to what is reasonably necessary for the continued operation of the debtor in the ordinary course of business during the ten-day “come-back” period after the granting of the initial order.
Creditors are subject to limited duties in a formal insolvency process. These include in the context of proceedings under the BIA and CCAA, the statutory duty to act in good faith with respect to those proceedings. Creditors are also subject to restrictions and obligations that may be included in an order of the court. Subject to compliance with these requirements, creditors can vote and participate in insolvencies in their own individual economic interest. For instance, the standard form of Ontario initial order under the CCAA and appointment order in the context of receiverships, both contain important restrictions on creditor actions during the proceedings.
There is no “cram-down” in an out-of-court restructuring or work-out. Indeed, if the landscape of stakeholders is complex and a compromise is required from each, an out-of-court agreement may be elusive. In this regard, out-of-court solutions are normally achieved where a small number of stakeholders are in a position to negotiate a compromise that does not require agreement from a wider group.
It is not uncommon (arguably typical) for large syndicated credits to include provisions permitting a majority (or super-majority) of lenders to bind dissenting lenders. The presence or absence of such provisions and the threshold for the contractual cram-down are a matter of negotiation. Indeed, the scale of the Canadian credit markets has the practical effect of lenders being very familiar with each other and interacting with each other regularly in multiple syndicates. Syndicate co-operation in the face of debtor restructurings is the norm and syndicate conflict is less common because the syndicate members value stable relations across a large number of credits over winning a single syndicate battle. Conflicts do occur but are not common.
Informal processes are not perceived as unworkable. A distressed investor may decide to acquire the secured debt as part of an acquisition transaction arising from an informal restructuring in order to retain that secured creditor’s leverage in negotiations with remaining stakeholders after an acquisition is consummated. The implied threat of a formal restructuring with its declining returns to stakeholders and associated costs of recovery often facilitate a post-acquisition negotiated solution among rational economic actors. If a material stakeholder or group of stakeholders continues to refuse to come to an agreement, the investor may trigger the pressure of a filing to bring these stakeholders to the table. Failing a negotiated solution, recourse to a formal process may be necessary.
In the common law provinces of Canada, security over personal property (both tangible and intangible) is usually taken under a general security agreement granting a security interest in all property, undertakings and assets of a debtor. Real property can be charged by way of a mortgage registered on title. In addition to a general security agreement, a lender may wish to take specific types of security against specialised personal property like shares, which can be accomplished by way of a supplementary share pledge. Debenture security may also be taken over real and personal property. Banks licensed in Canada can take specialised types of security under the Bank Act.
In the province of Quebec, the only civil law jurisdiction in Canada, security is obtained by way of hypothecs that can charge both moveable and immovable property.
Outside of an insolvency process, secured creditors may exercise their contractual rights and avail themselves of the sale and foreclosure regimes prescribed by real and personal property legislation. These regimes prescribe statutory notice periods. Additionally, if a creditor is seeking to enforce on all or substantially all of a debtor’s property, it is required under the BIA to provide ten days’ notice of its intention to enforce its security.
In formal insolvency proceedings (other than bankruptcy), secured creditors are subject to the stay of proceedings, subject to limited exceptions. For instance, if the ten-day notice period described above has elapsed, a secured creditor will not be subject to the stay of proceedings in a proposal proceeding. In a bankruptcy, secured creditors are not stayed and may enforce their rights.
Under the BIA, the vesting of title to a debtor’s assets in the trustee in bankruptcy (“trustee”) and distributions to unsecured creditors are subject to the claims of secured creditors. To the extent of their validity, enforceability and perfection, and subject to limited statutory priorities, secured creditors have priority against a trustee and unsecured creditors. A bankruptcy order does not stay secured creditors.
In an insolvency, creditors’ claims generally rank as follows.
Super-priority and secured claims are paid out of proceeds from sales during the insolvency proceedings in accordance with their respective priority. Where there is a surplus following satisfaction of super-priority and secured claims, the surplus is distributed to preferred unsecured claims and then ratably among general unsecured creditors.
Claims of creditors have priority over the claims of shareholders.
Unsecured creditors are not required to supply goods or services, or provide credit, to a debtor without assurance of payment for post-filing goods or services. Unsecured creditors may require that any such goods or services be provided strictly on a cash on delivery basis. They are therefore able to ensure they are kept whole during the restructuring process for post-filing goods or services.
Unsecured creditors have the right to commence an action to recover their debt and apply to court for an order adjudging the debtor bankrupt. These remedies are stayed when insolvency proceedings begin. Unsecured creditors have the ability to prove their claim in a bankruptcy, CCAA plan or proposal and receive a dividend based on the pro rata value of their claims relative to the claims of all other unsecured creditors.
Pre-judgment attachment is available to creditors in appropriate circumstances. Laws of general application and those specific to restructuring and insolvency provide for general attachment.
Remedies under laws of general application include court orders providing for injunctive relief, prohibiting certain acts by debtors or prescribed dealings with particular assets. In addition, “Mareva” injunctions can prohibit debtors from dissipating or concealing assets, or transferring assets out of jurisdiction. Any creditor who can demonstrate that there is a serious issue to be tried, or good case on the merits of their underlying claims, and meet the relatively high thresholds for demonstrating irreparable harm and balance of convenience may be entitled to the injunction.
Secured and unsecured creditors seeking bankruptcy orders have remedies that share some of the characteristics of pre-judgment attachments. A secured creditor who has delivered a notice of intention to enforce security under Section 244 of the BIA (a ”244 Notice”) may seek the appointment of an interim receiver to conserve the debtor’s estate, pending the expiry of the applicable ten-day notice period. An unsecured creditor who has filed a bankruptcy application may seek the appointment of an interim receiver to conserve the debtor’s property, pending the hearing of the bankruptcy application.
The BIA and CCAA provide the court overseeing CCAA, proposal and receivership proceedings jurisdiction to make orders granting super-priority charges that will rank ahead of secured creditors to the extent such creditors have received notice of the proposed charges. The charges can include the following.
The BIA also contains statutory provisions granting priority charges (or similar protections in the context of CCAA proceedings) protecting employees’ claims for unpaid wages and vacation pay for the six months period preceding the commencement of the proceedings, up to CAD2,000 per employee. The charge covers account receivables, inventory and cash of the debtor. A similar charge against all assets of the debtor protects certain prescribed unremitted pension contributions. Finally, the CCAA provides that a court may not approve a CCAA plan unless it is satisfied that an employer’s unremitted source deductions (such as income taxes, unemployment insurance premiums and Canada pension plan premiums) that were outstanding at the time of filing will be paid during the six months period following implementation of the CCAA plan.
CCAA and Proposal proceedings are the main Canadian restructuring proceedings. An alternative to these proceedings, in certain circumstances, are the arrangement provisions contained in the Canada Business Corporations Act and equivalent provincial corporate statutes.
The principal objective of the CCAA is to enable a debtor to formulate a plan of compromise or arrangement (the “plan”) in respect of the obligations it owes its creditors, to be voted on by the creditors, and if approved by the requisite majorities in each class of creditors, sanctioned by the court.
In many CCAA proceedings, the debtor will not file a plan but will rather use the proceedings as a mechanism to effect a sale of all or part of its business, property or assets, through either the implementation of a sale process, or a pre-packaged sale transaction that was formulated prior to, but consummated as part of, the CCAA proceedings.
Either a creditor or the debtor can initiate CCAA proceedings by application to the court.
To proceed under the CCAA, the debtor must:
The court will exercise its discretion to grant protection if:
Provided the applicant establishes that the debtor meets the CCAA requirements, the burden will be on any opposing creditors to show why the court should not grant the relief requested.
The court will appoint a monitor that is a licensed insolvency trustee (LIT), to oversee the proceedings, report on the debtor’s business and financial affairs, and assist the debtor in formulating its plan.
The debtor remains in control of its business and property; however, it remains subject to the monitor's scrutiny. If a transaction is outside the ordinary course of business or does not comply with any court order, the monitor will report such activities to the court.
The court will issue an initial order prohibiting all persons from taking any further steps to pursue claims against the debtor and its directors and officers, without the prior consent of the debtor and monitor, or leave of the court.
CCAA proceedings do not have a prescribed time limit. The initial order grants the debtor up to ten days of protection from its creditors. Before the expiry of that period, the debtor must return to court to request an extension. There is no limit on the length or number of extensions that a debtor may seek from the court, provided the applicant shows that circumstances exist that make the order appropriate and that it has acted and is acting in good faith and with due diligence.
For a Plan to be accepted by creditors, a meeting must be held for voting on the plan, and a majority in number of each class of creditors holding two thirds in value of the total debt represented by that class, must vote in favour of the plan. Once the requisite majorities of creditors in each class approve the plan, the court must sanction it before it becomes binding on all creditors.
After the implementation of the Plan and the conclusion of the proceedings, the debtor can resume its normal business operations.
The objective of proposal proceedings is to enable a debtor to reach a compromise with its creditors through a restructuring of its obligations pursuant to a proposal. The debtor may also use proposal proceedings to effect a sale of all or part of its business or assets.
An insolvent person, a receiver, a liquidator, a bankrupt, or a Trustee may make a proposal. There is no minimum debt requirement for companies to be eligible to make proposals. A proposal is initiated by filing a proposal or a notice of intention to make a proposal (NOI).
To proceed with a Proposal, the debtor must:
The Office of the Superintendent in Bankruptcy (OSB) will appoint a trustee to supervise the Proposal. Its role is to monitor the debtor’s actions, assist it in developing the proposal, and advise the court if any material adverse changes occur.
The debtor remains in control of its property; the trustee does not control the debtor’s affairs.
Secured creditors may enforce their security only if they have a 244 Notice and the statutory ten-day notice period has lapsed or been waived by the debtor. All other creditors are stayed for an initial period of 30 days. The time for filing a proposal (and the stay period) can be extended by the court for a maximum period of six months (including the initial 30-day stay), in 45-day intervals.
The creditors and the court must approve the proposal. At least two thirds in value and a majority in number of the creditors, including secured creditors to whom the proposal was made, must approve the proposal. Following the creditors' approval, the court will sanction the proposal if it is for the general benefit of the creditors. The court must be satisfied that the debtor’s creditors will be better off under the proposal than they would be in a bankruptcy.
Once the debtor has fulfilled its obligations in the proposal, the trustee will issue a certificate confirming the debtor’s compliance with its obligations under the proposal. Once the trustee issues the certificate, the debtor will have completed its restructuring and may resume normal operations. If the debtor defaults on its obligations, the proposal may be annulled and the debtor will be deemed bankrupt. The same will occur if the creditors do not approve the proposal.
Proceedings under the BIA and CCAA result in the debtor obtaining a stay of proceedings, whether automatically by statute or by order of the court.
A debtor subject to CCAA or proposal proceedings may obtain DIP financing (see 3.3 New Money).
For the purposes of voting on proposals or plans under the CCAA, creditors are placed in classes. The voting requirements in proposals and plans (a majority in number and two thirds by value of the creditors present and voting at a properly constituted meeting) apply on a class by class basis. Proposals must be made to all unsecured creditors, classed as is appropriate, and may be made to secured creditors.
Creditors are organised into classes based on their commonality of interest. In assessing commonality of interest, the rights of creditors are taken into account. The analysis is objective and includes the principle of non-fragmentation of creditor groups and the underlying purpose of facilitating arrangements between debtors and creditors.
There is no statutory basis for creditors’ committees in Canada and they are not common. Creditors form ad hoc committees in some cases.
The BIA and CCAA contain disclosure requirements. These include duties on court officers and debtors such as:
Receivers and trustees also have disclosure requirements which include creditor notices, creditors lists and discharge reporting.
The CCAA also permits “interested persons” to apply for orders requiring a creditor to disclose any aspect of their economic interest in the debtor.
There is no provision permitting an inter-class “cram-down”. Proposals and plans will be binding on dissenting creditor minorities within a class if approved at a properly constituted meeting by the requisite majorities and subsequently sanctioned by the court. If the requisite majorities are not obtained for any class, a proposal or plan will not be binding on that class. If court approval is not granted for a proposal or plan, it will not be binding on an affected class.
There are no general restrictions on trading the debt of a company undergoing a formal restructuring. Such claims may be recognised as provable claims. Trading of such claims can be structured as either assignments or outright sales. There is no strict time limit on when any claims may be traded. Claims purchasers need to be mindful of claims bar dates, and claims procedures implemented in insolvency proceeding. Specifically, they may want to ensure that any claims they purchase are not time-barred in the claims procedure itself and be aware of any record dates for voting at creditor meetings.
Multiple debtors within a corporate group can commence insolvency proceedings. Procedural (or administrative) consolidation can avoid unnecessary multiplicity of proceedings. Under procedural consolidation, estates of related debtors are jointly administered but each debtor’s assets and liabilities are kept separate.
It is rare for a court to allow “substantive consolidation”, ie, a consolidation of the assets and liabilities of multiple debtors. The situations where such relief is granted are limited given the prejudice it may have on creditors.
As a general principal, a debtor will seek court approval prior to the sale of assets that are non-deminimis in value.
In CCAA and receivership proceedings, the initial order and appointment order sets out a dollar threshold at which court approval must be obtained prior to consummating a sale transaction.
In determining whether a transaction should be approved, a court will consider, among other things:
The structure and process for disposal of assets or sale of a going concern business in an insolvency context depends on which of the insolvency legislation is being used to transact the sale.
With limited exceptions, the debtor runs the process for assets and going concern sales. Following negotiations with its primary creditors, the debtor will often seek approval of the court for an order that prescribes a sales and investment solicitation process (SISP) that involves varying degrees of involvement of, and supervision by, the monitor. Where the board of directors of the debtor or management is unwilling to be involved in the SISP, not resourced sufficiently to run it or is in a conflict of interest (ie, debtor management/shareholders are potential buyers) the court may order the monitor to have a much higher degree of control over the SISP. DIP lenders and secured creditors (often but not always the same or related entities) may also be granted rights to information and input into a SISP. The court may permit or even mandate the hiring of a “sales agent” to run the SISP.
Going concern sales and sales of assets in bulk or by lot of “material” assets will require approval of the Court. In such circumstances, the debtor will apply to the Court for an approval and vesting order. This order will approve the sale transaction and also provide for a vesting out of all pre-existing secured and unsecured claims against the purchased assets such that the buyer acquires the debtor’s title free and clear of claims and liabilities asserted against those assets.
It is also possible to use a formal CCAA compromise or plan of arrangement to have a plan sponsor acquire the equity of the debtor (extinguishing all pre-plan equity) and have a plan approved by the affected creditors which would permit the acquisition in return for a payment of a compromised amount of the liabilities to the creditors. The funding of that compromise payment would form part of the plan and would be made by the plan sponsor upon successful plan implementation. The plan sponsor would then acquire the business subject only to uncompromised liabilities it has agreed to assume.
The board of directors and management of the debtor generally run any sale process. Like the CCAA context, there may be a SISP. The proposal trustee appointed under the BIA to help the debtor will generally be involved in any sale process and will help debtor management and the board of directors consummate a sale. If that sale process does not result in a transaction, it is likely that the court will be asked by creditors to convert the BIA proposal process into a receivership or a bankruptcy.
Acquirers in a BIA proposal sale process will also have the benefit of an Approval and Vesting Order.
In a court-appointed receivership the receiver will either sell the assets of the business in bulk or in lots. Where the receiver is operating the business as a going concern it may attempt to sell the business as a going concern however the sale will still take the form of an asset sale. The receiver is an officer of the court who must act in the interest of all creditors, however, in conducting a sale process, the receiver will usually consult creditors who are likely to be impacted by the transaction, typically secured creditors since few receiverships result in payments to unsecured creditors.
Acquirers in a court-appointed receivership proceeding will also have the benefit of an Approval and Vesting Order.
If a debtor is adjudged a bankrupt or assigns itself into bankruptcy the sale of assets will be run by the bankruptcy trustee for the benefit of the unsecured creditors. A bankruptcy trustee can only sell the assets of the debtor not encumbered by security unless the secured creditor consents to the trustee’s sale or the secured creditor seeks the appointment of the trustee also as a court-appointed receiver of the bankrupt debtor.
Secured creditors can, and do frequently credit bid in CCAA, BIA proposal and receivership proceedings and these can be structured as stalking horse bids. Sales under these regimes are all court-supervised as noted above and as such there are no special rules for them beyond the test of the prudency of the sale used by court in that context.
Unsecured credit bids are uncommon given the propensity of Canadian secured creditors to take “blanket security” and given the significant shortfalls suffered by unsecured creditors. It is not a conventional practice in Canada.
Pre-negotiated or pre-packaged sales process are not uncommon. Most often, a pre-packaged sale process follows an informal SISP run prior to the proceeding which lends credibility to an abbreviated process post filing. The debtor enters the proceeding with the bird in hand being either a stalking horse bid requiring an abbreviated post-filing SISP process or a sale to be approved immediately following filing with compelling evidence to support the abridgement or complete avoidance of a post-filing sale process. Pre-packaged sales require either a significant pre-filing SISP process or some existential threat to the value of the business necessitating an expedited sale approval. It is common in such circumstances for the key stakeholders who might object to the abbreviated or eliminated post-filing sale process to be supporting the application for an expedited process.
It is common as part of any sale approved by the court that all secured claims and liens that are attached to the assets being sold be vested out by order of the court so that the purchaser obtains clear and free title to the assets.
Additional financing can be obtained by the debtor subject to insolvency proceedings. This financing is called interim financing or DIP financing and is available in CCAA proceedings and BIA proposals, see 3.3 New Money.
The BIA requires creditors to formally prove their claim against the insolvent debtor in order to vote on and participate in proposals. The BIA provides prescribed forms and procedures for proving claims. Claims are adjudicated in the first instance by the proposal trustee, subject to rights of appeal to the court. Claims not proven in advance of a creditors meeting cannot be voted. Claims not proven prior to the implementation of a proposal cannot participate.
Under the CCAA, the supervising court commonly makes orders prescribing the procedure for proving and determining claims and establishing dates after which they will be barred as against the insolvent debtor if not proven. Generally, monitors appointed in CCAA proceedings administer these claims processes. The effects of proving or not proving claims on voting and participation in respect of plans of compromise or arrangement are very similar to those applicable to BIA proposals.
Proposals under the BIA and plans of compromise or arrangement under the CCAA are not binding unless approved by the supervising court, even if approved by the requisite creditor double majorities. Before approving a proposal or plan, the court must be satisfied that the plan is fair and reasonable and that the provisions of the applicable insolvency statute and any prior court orders have been strictly complied with. In determining the fairness and reasonability of a proposal or plan, courts will compare the treatment of creditors under the proposal or plan to the treatment that they would receive in bankruptcy or liquidation.
Insolvent debtors restructuring under the BIA or the CCAA are specifically empowered to disclaim executory contracts, with certain exceptions. In order to disclaim a contract, debtors must obtain the approval of the applicable court officer and provide notice in the prescribed form to the contract counterparty. Contract counterparties may object to the disclaimer of their contracts within 15 days of the giving of notice and apply to the court for an order giving effect to their objection. In determining whether or not a contract should be disclaimed, the court will consider whether the proposed disclaimer is approved by the court officer, whether it will enhance the prospect of a viable proposal or plan being made and whether it is likely to cause significant hardship to the contract counterparty. The following contracts are not subject to disclaimer:
A court supervising restructuring proceedings may make an order releasing claims against parties other than the debtor provided that the court is satisfied that the releases are reasonably connected to the restructuring. The court will consider:
Third-party releases have included professionals involved in the restructuring, secured creditors, and affiliates of the debtor. Third-party releases have also been included in corporate plans of arrangement though they have been met with some reluctance by the courts.
During insolvency, a right of set-off can arise by law, in equity or by contract.
Legal set-off. There are two requirements that must be met for the claim of legal set-off to be made:
Equitable set-off. Unlike a set-off arising by law, an equitable set-off does not require the claims to be liquidated, enforceable and mature, or be mutual. However, when determining if equitable set-off is available, the courts will inquire into the connection between the claims and examine the general equities between the parties. Equitable set-off is available where it would be manifestly unjust to allow one claim to be enforced without taking the other claim into account.
Contractual set-off. The remedy of contractual set-off is the recognition of the entitlement of parties to explicitly contract to allow for setting-off obligations owing between them. A party with a contractual entitlement to set-off is not required to meet the threshold for legal or equitable set-off.
Under the BIA, where there is default in the performance of a proposal, the proposal trustee must give notice of default to the creditors and the government insolvency regulator. Following default, or where it is determined that the proposal cannot continue without injustice or undue delay, the court is empowered to order that the proposal be annulled. The court may also annul proposals obtained by fraud. If a proposal is annulled, the debtor will be deemed to have made an assignment in bankruptcy and a Trustee will be appointed.
Under the CCAA, where there is default in the performance of a plan, upon application by a creditor or the monitor, the court is empowered to make whatever order is just in the circumstances, including an order adjudging the debtor to be bankrupt.
Equity claimants may not vote at meeting of creditors unless the court orders otherwise. Proposals and plans cannot provide for the payment of equity claims unless all other claims are paid in full.
The formal liquidation of an insolvent debtor is most commonly carried out through bankruptcy proceedings pursuant to the BIA. In the context of liquidation, bankruptcy is intended to provide for the fair distribution of the debtor's unencumbered assets among its unsecured creditors.
In bankruptcy, the pre-bankruptcy remedies of a debtor’s unsecured creditors are replaced with the right to file a claim and receive a dividend in the distribution of proceeds resulting from the liquidation of the bankrupt debtor’s unencumbered assets. However, secured creditors of a bankrupt debtor can also enforce their security outside of the administration of bankruptcy.
Under the BIA, a debtor is considered bankrupt when they:
A bankruptcy can be initiated in three ways where the debtor is insolvent. First, the debtor may voluntarily assign itself into bankruptcy. Such proceedings are commenced by the Trustee selected by the debtor filing an assignment in bankruptcy made by the debtor with the Superintendent of Bankruptcy. Second, a debtor may be involuntarily placed into bankruptcy by an order of the court on application by one or more of the debtor’s creditors. Finally, a debtor may become bankrupt as a result of the failure of proposal proceedings under the BIA.
For a corporate debtor, voluntary initiation also requires the company's board of directors to pass a resolution before the court approving the assignment into bankruptcy.
Once the bankruptcy is effective, all the debtor's property and assets vest in the trustee (subject to the rights of secured creditors) and the debtor ceases to have any control over its affairs. In a corporate bankruptcy, the trustee replaces the management of the corporation and assumes full control over all of the debtor’s assets and property. On bankruptcy, the trustee proceeds to administer the estate for the benefit of the bankrupt's unsecured creditors. Secured creditors retain their right to enforce on their security, provided they do so in a commercially reasonable manner.
In order to participate in any distribution of the bankrupt’s estate, creditors must file a proof of claim with the trustee in the manner and form prescribed under the BIA. Where such a claim is allowed, said creditor will, in accordance with the priority regime set out under the BIA, be eligible to potentially share in the recovery from any realization on the property of the bankrupt debtor. Creditors whose claims are disallowed by the trustee may appeal the trustee’s decision to the court.
The debtor’s assets are distributed to unsecured creditors on a pro rata basis in accordance with the creditors’ proven claims. Such distributions are made only after secured creditors have realised their security and after super-priority and preferred creditors have been paid.
Under the BIA, a bankrupt corporation is not eligible to obtain a discharge from bankruptcy unless it has satisfied the claims of creditors in full. Unlike a BIA proposal, there is no specified timeline for corporate bankruptcy proceedings.
Once the trustee has administered the estate for the benefit of the bankrupt's unsecured creditors, the trustee applies to the court for a discharge from their duties.
The BIA provides for the enforcement of security and the appointment of a receiver on a national basis. As noted above, a 244 Notice must be delivered prior to a secured creditor enforcing its security on all or substantially all of the property and assets of an insolvent debtor. Once the 244 Notice period has lapsed (or, if the debtor has consented to an earlier enforcement at the time of the delivery of the 244 Notice) a secured creditor may proceed with applying for the appointment of a receiver.
The jurisdiction for the court appointment of a receiver is found in the applicable provincial judicature acts, rules for court proceedings, under Section 243 of the BIA, and under certain specific statues (for instance securities legislation).
The court appointment of a receiver typically commences by a secured creditor bringing an action or application against the debtor. The receiver is then appointed in a summary proceeding within that action or application.
A court order appointing a receiver typically:
Unlike privately appointed receivers, whose duty is primarily to the appointing secured creditor (subject to a general duty to act in a commercially reasonable manner), a court-appointed receiver is an officer of the court and has a duty to protect the interests of all the debtor's creditors.
Once the receiver is appointed, the receiver’s duties include:
The main restructuring and rescue procedures in Canada are proceedings pursuant to the CCAA and proposal proceedings pursuant to Part III of the BIA.
In addition, in appropriate circumstances, the arrangement provisions contained in the Canada Business Corporations Act and equivalent provincial corporate statutes may be used as an alternative to the formal insolvency proceedings under the BIA and CCAA outlined below.
See 6.1 Statutory Process for a Financial Restructuring/Reorganisation.
The principal objective of the CCAA is to enable a debtor to formulate a plan of compromise or arrangement in respect of the debtor's obligations owing to its creditors, to be voted on by the creditors, and if approved by the requisite majority in each class of creditors, sanctioned by the court overseeing the debtor's CCAA proceedings.
Despite this objective, in many CCAA proceedings, the debtor will not formulate or file a plan of arrangement, but rather uses proceedings under the CCAA as a mechanism to effect a sale of all, or part of its business, property and/or assets, through either the implementation of a sales or liquidation process, or a pre-packaged sale transaction that was formulated prior to (but consummated as part of) the CCAA proceedings.
Either a creditor or the debtor can initiate CCAA proceedings by application to the court. CCAA proceedings can only be commenced in respect of insolvent corporations with outstanding debts in excess of CAD5 million.
Generally, the court will exercise its discretion to grant protection if:
Provided the debtor (or creditor as the case may be), can establish that the debtor meets the requirements of the CCAA, the burden will be on any opposing creditors to show why the court should not grant the relief requested.
As noted, to proceed under the CCAA, the debtor must:
Under the CCAA, a monitor is appointed to oversee the proceedings of the debtor, report on the debtor’s business and financial affairs from time to time, and to assist the debtor with the formulation of its plan of reorganisation.
The CCAA is a debtor-in-possession regime meaning the debtor remains in control of its business and its property and assets. However, the debtor remains subject to the monitor's scrutiny and if a transaction is outside the ordinary course of business, or does not comply with any court-imposed restrictions, the monitor will report such activities to the court. The debtor is subject to the overall supervision of the court.
Where a debtor is granted protection under the CCAA, the court will issue an initial order prohibiting all secured and unsecured creditors from taking any further steps to pursue any existing or future claims against the debtor and its directors and officers, without either the prior consent of the debtor and monitor or leave of the court.
CCAA proceedings do not have a prescribed time limit. After the making of the initial order, the debtor is granted up to ten days of protection from its creditors. Within the initial stay period, the debtor must return to court to request an extension. After the initial protection period, there is no limit on the length of any extension or on the number of extensions that a debtor may seek from the court, provided the applicant seeking the extension can show that circumstances exist that make the order appropriate and that the applicant has acted and is acting in good faith and with due diligence.
For a reorganisation plan to be accepted by creditors, a meeting must be held for the purpose of voting on the reorganisation plan, and a majority in number of each class of creditors holding two thirds in value of the total debt represented by that class, must vote in favour of the plan. Once the reorganisation plan is accepted by the requisite majority in each class of creditor, the plan must be approved by the court before it becomes binding on those classes of creditors that voted in favour of the plan.
Once the CCAA reorganisation plan is approved by the requisite majority of the debtor's creditors in each class and is thereafter sanctioned by the court, the debtor will have successfully concluded a compromise or arrangement with its creditors with regard to the debts owed to such creditors before the commencement of CCAA proceedings, provided that the payments or consideration required under the CCAA and the plan are made or provided when required.
After the implementation of the plan and at the conclusion of the CCAA proceedings, the debtor can resume its normal business operations.
See 6.1 Statutory Process for a Financial Restructuring/Reorganisation.
The objective of proposal proceedings pursuant to the BIA is to enable a debtor to reach a compromise with its creditors through a restructuring of its obligations pursuant to a proposal. Proposal proceedings under the BIA may also be used by the debtor as a mechanism to effect a sale of all or part of its business, property and/or assets.
Under the BIA, a proposal may be made by an insolvent person, a receiver, a liquidator of an insolvent person’s property, a bankrupt, and a trustee of the estate of a bankrupt. There is no minimum debt requirement for companies to be eligible to make proposals under the BIA.
A BIA proposal is initiated by either filing a proposal or filing a notice of intention to make a proposal. On the filing of the Notice of Intention, all creditors are stayed for an initial period of 30 days (unless a secured creditor has filed a 244 Notice and the statutory ten-day period has expired).
To proceed with a proposal under the BIA, the debtor must:
Once the debtor has filed either a proposal or a Notice of Intention, the court will appoint a trustee to supervise the proposal process. The role of the trustee in BIA proposal proceedings is to monitor the debtor’s actions, assist the debtor in developing the proposal and in reaching a compromise with its creditors, and to alert the court if there are any material adverse changes.
The debtor remains in control of its property and assets throughout the duration of BIA proposal proceedings and the appointed trustee does not directly control the debtor’s affairs.
As noted, once a proposal or notice of intention has been filed, no creditors can bring or continue any proceedings against the debtor. The stay of proceedings prohibits creditors from exercising any remedy against the debtor or its property, or commencing or continuing any action, execution or other proceeding for the recovery of a claim provable in bankruptcy without leave of the court granted on motion on notice to the debtor and the proposal trustee.
Secured creditors may enforce their security interest only if they have served a Section 244 Notice on the debtor and the statutory ten-day notice period has lapsed (or the debtor consented to an earlier enforcement by the secured creditor at the time that the Section 244 Notice was delivered by the secured creditor, or thereafter).
BIA proposal proceedings proceed on defined time limits. On the filing of a notice of intention, all creditors are stayed for an initial period of 30 days. The time for filing a proposal (and the stay period) can be extended by the court for a maximum period of six months (including the initial 30 day stay), in 45-day intervals.
Both the debtor’s creditors and the court must approve of a proposal pursuant to the BIA. At least two thirds in value and a majority in number of the creditors, including secured creditors to whom the proposal was made, must approve of the proposal. Following the creditors' approval, the court will approve the proposal if it is for the general benefit of the creditors. To this extent, evidence must be adduced to show that the debtor’s creditors will be better off under the terms of the proposal than they would be if the debtor were liquidated pursuant to bankruptcy proceedings.
Once the debtor has fulfilled all of its obligations as set out in the BIA proposal, the trustee will issue a certificate confirming the debtor’s full compliance with its obligations under the proposal. Once the trustee’s certificate is issued, the debtor is considered to have completed its restructuring and may resume normal operations of its business. However, if the debtor defaults on its obligations to its creditors under the proposal, as approved by its creditors and the court, its proposal may be annulled. Similarly, if a debtor’s proposal is rejected by creditors by a majority in number or one-third by value, the debtor will be deemed to be bankrupt.
See 6.8 Asset Disposition and Related Procedures for court supervised disposal of assets and businesses.
Distressed sales of assets and/or businesses can and do occur outside of the formal insolvency court proceedings highlighted in 6.8 Asset Disposition and Related Procedures. However, such “self help” or “consensual” sales processes can be either (or both):
The statutory distribution schemes for the proceeds of sale flowing from any such statutory notices of sale are prescribed by legislation and cannot be altered except by consensual arrangements made with secured creditors who otherwise have the protection of the priority scheme thereunder.
If the sale transaction is consensual the purchaser contractually confirms the release of security with the secured creditors. If the transaction is under the above noted provincial enforcement regimes in order to obtain clear title free of secured claims the enforcing creditor must be a first ranking creditor thereunder. Otherwise, prior ranking security is not impacted by the notice of a subordinate ranking secured creditor. Court approval and vesting orders provide the highest degree of certainty where priority in the debtor’s collateral is in dispute.
Credit bids generally occur in the context of a formal proceeding. However, it is possible to structure debt to equity conversions/debt forgiveness transactions where a secured creditor acquires equity in the debtor by private agreement and generally as a part of a recapitalisation of the debtor outside of formal proceedings. These types of consensual balance sheet readjustment with secured creditors receiving an equity stake are not as common as formal proceedings but can be a very effective tool to avoid the costs and business disruption inherent in formal proceedings. These types of structures are most commonly used where the secured creditors would otherwise suffer a significant loan loss in the absence of the private arrangement.
In bankruptcy, creditors of the bankrupt appoint inspectors to represent their interests. Appointing an inspector is mandatory in corporate bankruptcies. Inspectors may also be appointed in proposal proceedings, however, that is optional.
There is no requirement or statutory framework under the CCAA or the BIA for the formation of creditors’ committees. Creditors’ committees have been recognised by courts in limited circumstances, and granted court-approved funding.
Both the CCAA and BIA contain provision allowing for recognising and co-ordinating with foreign proceedings as either a foreign main proceeding or a foreign non-main proceeding.
A foreign proceeding will be recognised as a foreign main proceeding in Canada where the debtor’s centre of main interest (COMI) is located in the foreign jurisdiction. A court will determine a debtor’s COMI by looking to, among other things, the location of the debtor’s management and headquarters, and the location that significant creditors recognise as being the centre of the debtor’s operations.
The definition of a “foreign non-main proceeding” in Canada is derived from the UNCITRAL Model Law of Cross-Border Insolvency 1997 and refers to any foreign proceeding other than a foreign main proceeding.
In limited circumstances, Canadian courts have entered into protocols with foreign courts to coordinate cross-border proceedings.
Whether the proceeding is determined to be a foreign main or non-main proceeding by a Canadian court has important implications on the treatment of that proceeding and the debtor in Canada. If the proceeding is determined by the Canadian court to be a foreign main proceeding, the debtor is entitled to certain automatic relief by the Canadian court.
The recognition provisions of the BIA and CCAA are largely modelled on the UNCITRAL Model Insolvency Law. Canada passed legislation adopting the treaty in 2005. The CCAA and BIA were amended in 2009 to incorporate the UNCITRAL Model Insolvency Law in a slightly modified form.
Foreign creditors are dealt with in the same manner as domestic creditors. That being said, absent a recognition order in their local jurisdiction, foreign creditors will not be subject to the stay of proceedings in their home jurisdiction.
Canadian courts may recognise foreign judgments. That is primarily a matter of common law although certain provinces have legislation that governs recognition of foreign judgments. In recognising a foreign judgment, Canadian courts will consider:
There are a number of defenses to recognising a foreign judgment, including on public policy grounds. Once recognised, a foreign judgment can be enforced in a manner similar to a domestic judgment.
Trustee in bankruptcy. In bankruptcy, the debtor's property vest in the trustee (subject to the rights of secured creditors) and the debtor ceases to have control over its affairs. The trustee replaces the management of the corporation and assumes control over the debtor’s assets. The trustee administers the estate for the benefit of the bankrupt's unsecured creditors. Secured creditors retain their right to enforce on their security. Trustees are licensed by the OSB to carry out the administration of all aspects of a bankruptcy. Trustees are court officers and act as fiduciaries for the benefit of the bankrupt’s creditors.
Monitors. A monitor oversees the proceedings, reports on the debtor’s business and financial affair and assists the debtor with the formulation of its plan. The monitor does not displace the debtor that continues to be in control of its property.
Court-appointed receiver. The BIA provides for the enforcement of security and the appointment of a receiver on a national basis over all or part of a debtor’s property. A receiver has broad power to market and sell a debtor’s assets with the oversight of the court. The receiver’s duties include:
Inspector. The role of inspectors is to oversee the bankruptcy and approve of certain actions, including the sale of most assets. Inspectors supervise the trustee on behalf of creditors, and instruct the trustee to act in a manner that is appropriate in order to protect the interests of creditors and the bankrupt estate.
One of the hallmarks of Canadian bankruptcy and insolvency proceedings is the mandatory requirement that an LIT be involved in a supervisory or advisory role, depending on the proceedings.
LITs are insolvency specialists that are licensed by the OSB. They are typically, but not always, accountants who have specialised in insolvency and have successfully taken the written and oral exams administered by the OSB.
See 9.1 Types of Statutory Officers.
A court officer, the trustee must act fairly, equitably, and impartially.
The BIA imposes numerous statutory duties on trustees, many of which are administrative in nature. The BIA also confers broad powers that a trustee can exercise with the permission of the inspectors appointed in the bankruptcy. Those powers include selling property, carrying on the business of the bankrupt, determining claims filed against the bankrupt, and compromising and settling debts of the bankrupt.
See 9.1 Types of Statutory Officers.
A court-appointed receiver is not an agent of either the debtor or the security holder but, rather, an officer of the court, subject to the court’s authority and direction and accountable to the court. A court-appointed receiver has a fiduciary duty to act in the best interest of all interested parties, including the debtor. A court-appointed receiver takes instruction from neither security holder nor debtor, and generally retains independent counsel.
A receiver must exercise prudence and reasonable care in the conduct of the Receivership and in dealings with the receivership property.
The BIA imposes the following statutory duties on receivers:
See 9.1 Types of Statutory Officers.
Restrictions on who may be monitor
In addition to the requirement that the monitor must be an LIT, there are restrictions on who may act as monitor.
No trustee can be appointed as monitor if, within the last two years, the trustee was a director, officer or employee of the debtor, related to the debtor, or any director or officer of the debtor; or the auditor, accountant or legal counsel of the debtor.
The monitor has many duties that are administrative in nature such as publishing orders and reports and filing prescribed documents with the OSB.
The monitor has duties that are substantive in nature such as reviewing the company’s cash-flow statements filed with the court and comment on them, advising on the reasonableness and fairness of a proposed plan, and report to the court on developments or changes in the proceeding.
The CCAA imposes an obligation on the monitor to act honestly and in good faith.
Obligations pursuant to Court Orders
The Initial Order and ensuing orders may require the Monitor to perform additional obligations. For example, they may empower the Monitor to monitor the debtor's receipts and disbursements, assist the debtor in dealings with its creditors and in preparing the required cash-flow statements.
The role of a proposal trustee is similar to that of a monitor.
A proposal trustee is an independent third party appointed by the OSB to assist the company with the filing of its NOI or proposal and to monitor the company's ongoing operations during the proceedings. A proposal trustee must be an LIT. The debtor continues to be in possession of its assets; they do not vest in the proposal trustee.
Duties include monitoring the business’ ongoing financial activities, reporting to the court on events that might affect the viability of the company, assisting the company in the preparation of its proposal, notifying the creditors of meetings of creditors and tabulating the votes at these meetings. The proposal trustee will also prepare a report on the proposal that is included in the mailing of the proposal to creditors.
Proposal trustees must report on the reasonability of the cash flows filed by the debtor on material adverse changes in the debtor’s affairs and on any proposal presented by the debtor.
The proposal trustee must advise the court on the terms of the proposal and the conduct of the debtor. The proposal trustee’s recommendation on the proposal will typically include a statement advising that the proposal offers more to a debtor’s creditors than they would receive in a Bankruptcy. If the proposal trustee cannot make this statement, it is likely that a court will refuse to approve a proposal.
The debtor will usually select court-appointed officers. If a creditor initiates the proceeding, that creditor will usually put forward its preferred officer. The appointment of a monitor or court-appointed receiver is not official until the court issues an order confirming the appointment. Although infrequent, a party may make a motion to the court asking for the officer to be replaced. This might occur in a case where the court is satisfied that an officer has a conflict of interest.
Statutory officers are restructuring professionals with business and accounting qualifications who assist the debtor’s employees in managing the operations during an insolvency proceeding as well as evaluating and making recommendations to the board of directors on restructuring alternatives available to the debtor. Trustees in bankruptcy and receivers displace the directors of the insolvent debtor in relation to dealings with the property, and may decide to continue to work with existing management. The debtor’s employees are not employees of the court-appointed officers though they work under their supervision and many of the decisions to be taken in a proceeding will require the court-appointed officer’s consent.
Only an LIT can act as trustee, proposal trustee, monitor or court-appointed receiver.
Corporate directors in Canada are subject to statutory and common law duties. Two general obligations that are imposed on directors are:
Corporate directors can attract personal liability under a number of provincial and federal statutes. For example, with respect to labour relations, personal liability is imposed on directors for unpaid wages, accrued vacation pay, and in certain cases, pension plan contributions that are due but unpaid.
Directors are personally liable for payroll remittances for amounts deducted from employees’ wages on account of income taxes, contributions to the Canada (or Quebec, as applicable) Pension Plan, and for employment insurance premiums.
Directors will not be held personally liable for the above to the extent they can show that they were duly diligent, or that the failure to remit the amounts required in a timely manner was due to circumstances beyond their control.
Furthermore, directors may also be held personally liable for a corporation’s default in payment of its goods and services tax or harmonised sales tax (HST) obligations.
Corporate directors may also be held personally liable if they are found to have acted improperly so as to cause a loss to the company’s creditors.
In appropriate cases, court officers have been authorised to commence claims for breach of duties owed by shareholders and others to debtors and their stakeholders. These claims are based on the oppression and derivative action provisions of applicable corporate law statutes. The commencement of these claims by a court officer generally requires leave of the court and evidence that it is more appropriate or practical for the court officer to bring the claims than creditors. Courts will also consider whether the commencement of these claims by a court officer will facilitate restructuring proceedings.
Assuming other applicable criteria are satisfied, creditors retain the ability to make claims for breach of duties owed by shareholders and others in respect of debtor. Courts will not permit a duplicity of claims. Claims for breach of duty owed to debtors must either be brought by creditors or court officers, not both.
A preferential transaction occurs where one creditor receives payment over another creditor before the initial bankruptcy event, or the date the CCAA proceedings were commenced, with the effect of the debtor preferring one creditor over another.
One of the following circumstances must exist:
A preferential is void and will be set aside by the court.
Transaction at Undervalue
A transaction at undervalue (TUV) occurs where the debtor was insolvent at the time the transaction occurred, or became insolvent as a result of the transaction, and the intent of the debtor was to defeat, delay or defraud its creditors.
For a transaction to constitute a TUV, it must have occurred:
Where a TUV occurs, a court can set aside the transaction, or order the recipient of the payment to pay the difference between what it paid for the property and the actual fair market value of that property.
Improper Payments by the Bankrupt Corporation
Under the BIA, a court may inquire into whether the following payments made by a debtor were made at the time when the corporation was insolvent (or such payment rendered the corporation insolvent):
If a court finds that such payments have been made improperly, judgment may be made against the directors of the debtor requiring repayment of such amounts.
These provisions place a reverse onus on the directors to prove that any of the aforementioned payments were:
Directors who objected to the corporation making payments of such benefits are exonerated from liability.
See 11.1 Historical Transactions.
A trustee or monitor can initiate proceedings to challenge a transaction as a preference or TUV.
Provincial legislation permits creditors to seek to set aside preferences and transactions to defeat, delay or defraud creditors.
Restructuring legislation in Canada enables financially distressed companies to avoid bankruptcy, foreclosure or the seizure of assets while maximising returns for their creditors and preserving both jobs and a company's value as a functioning business. Restructuring professionals generally accept that the ability of insolvent companies to restructure their businesses in a cost-efficient manner ultimately benefits all stakeholders. This article will review two legal matrixes that combine process efficiency with the remedial goals of insolvency legislation to facilitate the speedy recovery of a distressed debtor. This article will review one of the most topical trends in Canadian restructurings, an unconventional restructuring mechanism referred to as a "reverse vesting order" (RVO). Following this, a case scenario in which a debtor with international operations successfully restructured its business in three months will be discussed.
Canada’s Main Restructuring Statutes
The two main insolvency statutes in Canada for the restructuring of corporate entities are the Companies’ Creditors Arrangement Act (CCAA) and the bankruptcy and Insolvency Act (BIA). Larger companies with at least CAD5,000,000 in debt generally use the CCAA to effect their restructurings. The BIA contains a restructuring regime ("proposal proceedings"), liquidation provisions through the appointment of a receiver (a "receiver"), and a formal bankruptcy process ("bankruptcy").
Plans of Arrangement and Sales of Assets under the CCAA
The CCAA aims at facilitating the compromises and arrangements between companies and their creditors. At its core, the CCAA provides the ability for a company to extinguish claims against it pursuant to a plan of compromise (a "CCAA Plan") on which affected creditors have the right to vote. The party funding the consideration under the CCAA Plan will often receive the totality of the shares of the restructured debtor. For a CCAA Plan to be successful, creditors holding 50% in number and 66 2/3% in value of each class of claims voting on the CCAA Plan must approve the CCAA Plan, and the Court must sanction the Plan as fair and reasonable. Ultimately, the restructured debtor emerges as a financially viable entity with new ownership.
While CCAA plans are the primary restructuring mechanism described in the CCAA, it is also possible to effect a sale of some or all of a business or assets under the CCAA. In fact, sale transactions significantly outnumber CCAA Plans in the current restructuring landscape. The CCAA allows a debtor to dispose of its assets outside the ordinary course of business provided the Court is satisfied with a number of criteria. These elements include whether the process leading to the proposed sale was reasonable, whether the monitor ("monitor") appointed by the court to oversee the CCAA proceedings approves of the process and the sale, and whether the consideration for the assets is fair, reasonable and in excess of the consideration that creditors would receive in a bankruptcy.
In order for a purchaser to acquire assets free of an insolvent debtor’s claims ("claims"), the CCAA specifically authorises the court to order that the assets are conveyed free and clear of claims, and that the proceeds of the sale be subject to those claims in the same priority they held vis-à-vis the assets. This type of order is referred to as an approval and vesting order (AVO). While arguments arise from time to time on the type of claims that an AVO can vest out, AVOs are a generally accepted means of implementing a business restructuring.
Reverse Vesting Orders
At a high level, this mechanism provides for the transfer of unwanted assets and liabilities of an insolvent debtor ("FilingCo") to a shell company ("ResidualCo") pursuant to an order of the court, allowing the cleansed FilingCo to emerge as a solvent restructured entity. To date, RVOs have been used in CCAA, proposal and receivership proceedings. Here the focus will be on circumstances in which RVOs have been used in the CCAA context, their advantages, and the dichotomy between RVOs and the fundamental tenets of the CCAA.
Contrary to an AVO, an RVO transfers the claims of creditors to a ResidualCo (as opposed to transferring the assets to a purchaser, often a single-purpose newly incorporated entity) and allows the restructured FilingCo to emerge from insolvency protection. In that sense, an RVO is the reverse of an AVO. The CCAA does not specifically identify RVOs as a tool available to implement a restructuring. This does not however prevent CCAA courts from approving RVOs using the inherent equitable jurisdiction conferred upon them by the CCAA.
Canadian courts overseeing insolvency proceedings are recognised for using a liberal and purposive approach in interpreting the provisions of the CCAA.
In 2020, the Supreme Court of Canada (SCC) in 9354-9186 Québec inc v Callidus Capital Corp confirmed the broad jurisdiction of the CCAA courts subject only to the restrictions imposed by the CAAA, and the requirement that the order made be appropriate in the circumstances and furthers the remedial objectives of the CCAA. The SCC also identified considerations of appropriateness, good faith, and due diligence as baseline principles.
RVOs were practically non-existent in Canada until the decision of the 2019 Quebec Superior Court in Stornoway Diamond Corp et al (Re). Since then, there have been nearly 20 company restructurings effected via the use of this construct.
RVOs are useful when restructuring an entity that owns valuable assets that are not easily transferable such as licences, public listings or tax attributes (for example, losses or paid-up capital). We are now seeing them frequently in the restructuring of regulated entities such as mining or cannabis companies.
By allowing the existing insolvent corporate entity to retain its assets free of claims, purchasers avoid the risks or prohibitions normally associated with obtaining new licences, permits or accreditations. Similarly, the transfer of tax losses often results in little or no consideration to the creditors of a company, whereas they are often very valuable to the new owner of a restructured entity. Other business practicalities supporting the use of RVOs include avoiding transfer restrictions and consent requirements to the transfer of material contracts.
Time and cost savings
Importantly, the cost and time savings of implementing a transaction through an RVO are significant by contrast to a CCAA plan. An insolvent debtor under CCAA protection who presents a CCAA plan to its creditors must first identify all claims that will be the subject of the compromise. The creditors holding these claims must receive significant notice of the CCAA plan and of the meeting to vote on the plan. As noted above, the court must also sanction the plan. These steps can often take months to complete during which the struggling business continues to operate in an insolvency context.
The stigma, risks and delays associated with lengthy insolvency proceedings inevitably affect the value and viability of an operating business. Since RVOs only require the approval of the court, the restructuring of the operating business can be implemented considerably faster, leaving claim determination, if necessary, to be completed separately after FilingCo emerges from creditor protection.
To date, RVOs have been most commonly used in situations where no creditor opposed, no other alternatives were presented to the court and the value of the claims of unsecured creditors was nil or preserved to be determined at a later point in time.
In late 2020, the Quebec Court in Arrangement Relatif à Nemaska Lithium Inc. ("Nemaska") and the Alberta Court in Quest University Canada (Re) ("Quest") provided lengthy reasons in support of their decision to issue RVOs. Justice Gouin’s decision in Nemaska is the first instance in which a Court issued an RVO over the objections of a creditor. At the time of writing this article, there were only two other instances in which a requested RVO was opposed by a creditor. In both Nemaska and Quest, the opposing creditors argued that RVOs deprived them of the right to vote that they would have if the transaction was implemented pursuant to a CCAA Plan. The presiding Courts in both cases commented that those creditors appeared to be using their opposition as a bargaining tool or "working actively against the goals of the CCAA by their opposition to the RVO".
It remains to be seen how far Canadian courts will be willing to go to approve RVOs whether or not they opposed. Commercial courts in Canada with carriage of insolvency cases are sophisticated and pragmatic in implementing the goals of the CCAA. Courts are particularly sensitive to the social and economic consequences that arise when business restructurings fail. When asked to issue RVOs, judges must not only exercise their inherent jurisdiction within the confines of the CCAA but also delicately balance rescuing businesses and employment by contrast to creditors’ rights to vote on a fundamental change affecting them.
Selling a Business under the CCAA without a Court-Supervised Sale Process
Not every sale of an insolvent business requires the running of a court-supervised sales and investment solicitation process (SISP). Some circumstances draw us toward a process though less frequently used is faster and has a higher degree of certainty but requires a strong consensus among the stakeholders. The proceedings commenced by Hematite Holdings Inc and certain related entities (the "applicants" or the "company") in September of 2020 under the CCAA exemplify the non-SISP based sale of a troubled business by way of a CCAA Plan and Chapter 15 of the US Bankruptcy Code (collectively with the proceedings commenced by the applicants under the CCAA, the "proceedings").
Leading up to July 2020, the applicants in the proceedings suffered serious liquidity challenges that required bulge lending from their secured creditors. However, these lifeline loans proved to be insufficient. The COVID-19 pandemic and the resulting government-mandated shutdowns were dragging on and the applicants needed a long-term solution. From March to May of 2020, the company's gross sales were approximately 70% below expectations and it experienced a significant and unexpected operating loss.
In response to this crisis, the applicants privately commenced a search for an investor or buyer that would inject the cash necessary to keep the Applicants’ business running and avoid a shutdown of the supply chain that would ultimately impact their automotive original equipment manufacturer (OEM) customers. The applicants narrowed the search down to a single investor/buyer being Woodbridge Foam Corporation (the "sponsor"), a Tier I supplier with:
Immediately prior to the commencement of the proceedings, the applicants and the sponsor:
The applicants obtained protection under the CCAA on 18 September listing approximately CAD59.3 million in liabilities owed to secured and unsecured creditors.
The framework of the proceedings and steps towards success
The framework of the proceedings was prescribed by the SPA. Pursuant to the SPA, the sponsor agreed to fund both the DIP Loan plus an amount to be paid to the applicants and used to create a fund to be distributed to affected creditors (the "creditor fund"). The creditor fund would only be distributed to affected creditors if the CCAA plan were approved. On implementation, the CCAA plan contemplated the issuance to the sponsor of 100% of the equity of the parent of the applicants (and therefore indirectly all of the applicants). All pre-existing classes of equity, options and warrants would be cancelled.
For the CCAA plan to succeed, the applicants had to resolve all material outstanding issues with unaffected creditors and stakeholders (principally OEMs and tooling suppliers). This saw a significant number of tooling suppliers being paid in full over time on and after plan implementation. It would also see affected creditors whose claims would be compromised receiving a significant but compromised payment of the Applicants’ respective debts to them. The monitor’s assessment of the CCAA Plan was that it would provide a better outcome for affected creditors then the alternative liquidation.
Affected creditors voted nearly unanimously in favour of the CCAA plan. Following plan approval by affected creditors and the court, the creditor fund was distributed and the sponsor acquired the applicants. With a cleansed balance sheet, new capital and ownership with the means to put the debtor back in the black, the applicants came out of the proceedings. With careful planning and execution, the proceedings that were commenced on 18 September 2021 resulted in affected creditor approval at a meeting held on 11 December 2021 and plan implementation before year end 2021.
This shift from the prevalent liquidating CCAA proceedings with full blown SISP’s to this sort of sale by plan of compromise and arrangement is not likely to be an anomaly. The result in the Hematite CCAA proceedings was made possible by:
Supply chain volatility coming out of the pandemic continues to threaten the automotive sectors and other industries reliant on global supply chains and global steel prices. The probable breakage of these supply chains could have significant upstream impacts. The OEMs in every industry together with their key suppliers may very well turn to faster, more predictable and more cost-effective alternatives to sales processes in order to provide supply chain continuity and health. It is not a trend today but maybe it should be.