2009 Amendments – Court May Order that Charge Ranks in Priority to Secured Creditors

As part of the overhaul of the CCAA in 2009, the concept of “critical suppliers” was added to the CCAA. Pursuant to section 11.4 of the CCAA, on an application by a debtor company, a court can make an order declaring that a supplier is a critical supplier if the court is satisfied that the supplier provides a supply of goods or services that is essential for a company’s ongoing operations. Further, a court can compel critical suppliers to supply goods or services to a debtor on the terms and conditions that the court considers appropriate. If a court order compels a critical supplier to supply goods and services, a court must declare that all or part of the debtor’s property is subject to a security or charge in favour of the critical suppliers pursuant to subsection 11.4(3). The court may order that the charge ranks in priority over the claim of any secured creditor. Notice must be given to secured creditors who will be affected by the order.

The 2009 amendments change the circumstances surrounding stakeholders in a CCAA proceeding. An insolvent company no longer needs to rely on the credit of its DIP lender for all of its post-filing needs, but can instead rely on the credit of critical suppliers. This may reduce the cost of short term liquidity for an insolvent company as the company may not be required to draw on its DIP loan as frequently and may have less need of funding. In addition, unlike DIP lenders, critical suppliers designated pursuant to section 11.4 do not negotiate their position with the insolvent company and have no greater rights to information or access to the debtor than unsecured pre-filing creditors.

Recent Judicial Consideration of “Critical Supplier” Provisions of CCAA

Canadian courts have considered the application of section 11.4 in a number of recent proceedings. The CCAA proceedings of the Priszm group of companies (the “Priszm Proceedings”) involved an applicant that operated several hundred fast-food franchises. These franchises required the continual supply of numerous goods and services, such as food products, waste management, information technology and utilities.

The applicant sought an order declaring certain suppliers to be critical suppliers and requiring them to continue supplying on terms and conditions consistent with past practice and existing arrangements. The applicant also requested a charge as security for payment for the goods and services to be supplied. The court granted the order based on the applicant’s reliance on an uninterrupted flow of these supplies and the fact that any interruption of the supply would negatively impact the applicant’s ability to restructure. The court declared that certain parties were critical suppliers because their failure to supply would have had an immediate material adverse impact on the company’s business, operations and cash flow.

The CCAA proceedings in respect of Catalyst Paper demonstrate additional factors that a court will consider in making an order designating certain parties as critical suppliers. Catalyst Paper was a manufacturer of paper products. Paper production requires specialized equipment, numerous raw materials, a significant amount of energy and utilities, and numerous other inputs. Proceedings under the CCAA were commenced at the end of January 2012. Shortly thereafter, the court issued an order pursuant to section 11.4 of the CCAA designating some 16 suppliers as critical suppliers, ordering them to continue supplying goods and services to Catalyst Paper and granting a charge in their favour.

The company persuaded the court to declare that various suppliers were critical suppliers under section 11.4 by listing numerous reasons why the maintenance of pre-filing relations with suppliers was necessary for the company’s continuing operation. Reasons included that Catalyst Paper kept low levels of inventory on hand, delayed or stopped supply could disrupt Catalyst Paper’s operations, there were no alternative suppliers available for some of the goods and services, and Catalyst Paper’s business depended on the ongoing supply of certain goods and services.

A review of cases dealing with section 11.4 shows that courts apply this provision by assessing a debtor’s business needs. Each time a court has considered section 11.4, it has focused its reasoning on an examination of the impact of an interruption of supply on the debtor’s continued operations and its ability to restructure. Companies applying for a critical supplier declaration must make a business case to the court that demonstrates a supplier’s importance to its restructuring and operational success.

In Re Northstar Aerospace, Inc., the court recognized a limitation on court orders made under section 11.4. The court observed that an order compelling supply may not suffice to ensure a timely supply by a critical supplier located in a foreign jurisdiction. Northstar Aerospace Inc. (“Northstar”) was a manufacturer of components and assemblies for military and commercial aircrafts. Its operations were dependent, in part, on an ongoing supply of certain components provided by a supplier located in China. The court permitted Northstar to pay its pre-filing debt to the critical supplier despite also making an order under section 11.4 that compelled the critical supplier to supply goods to Northstar, given that the court could not ensure timely supply otherwise. This approach is aligned to the practical nature of the CCAA but may also open the door for suppliers to challenge compelled supply and demand payment for pre-filing debt.

Section 11.4 may give companies proceeding under the CCAA the benefit of improved short term liquidity and potentially lower borrowing costs. In contrast, compelled supply may force unwilling parties to supply on credit to insolvent companies without providing any protection beyond a critical supplier charge. It will be interesting to see how the courts strike a balance between the interests of the insolvent company, the interests of suppliers and the interests of other stakeholders in CCAA proceedings when granting orders under section 11.4.

This post was authored by Marc Wasserman, Patrick Riesterer and David Rosenblat.

Interim Financing Under the CCAA and “Roll-ups”

Section 11.2 of the Companies’ Creditors Arrangement Act (“CCAA”) gives the Canadian court explicit authority to grant a priority charge for amounts advanced by a lender to a CCAA debtor after the CCAA filing (a “DIP Loan”); however, the section provides that the charge may not be granted to secure an obligation that exists before the order is made. Section 11.2 effectively prevents a roll-up of pre-petition debt into a DIP Loan. A “roll-up” is an arrangement where all or a portion of pre-petition loans provided by a lender are “rolled-up” into the post-petition DIP Loan provided by the same lender, effectively giving the DIP lender the benefit of the DIP Loan charge for pre-filing obligations.

Roll-up Approved in Recent Cross-Border Proceeding

In the recent decision in Re Hartford Computer Hardware, Inc. et al., the Canadian court recognized an order of the United States Bankruptcy Court for the Northern District of Illinois Eastern Division (the “US Court”) granting a roll-up in a cross-border proceeding despite the prohibition on roll-ups in s. 11.2 of the CCAA.

Hartford Computer Hardware, Inc. and certain of its affiliates (collectively, “Hartford”) were subject to Chapter 11 proceedings in Illinois and those proceedings had been recognized in Canada as foreign main proceedings pursuant to Part IV of the CCAA.

Hartford had previously obtained from the Canadian court recognition of an Interim DIP Facility Order that had been granted by the US court. In a motion heard on February 1, 2012, Hartford sought approval of the Final DIP Facility Order. The Final DIP Facility Order contained a partial roll-up, whereby all cash collateral in the possession of Hartford on the day of the Chapter 11 filing or acquired afterward was deemed to have been remitted to the pre-petition secured lender for repayment of the pre-petition secured loan and a corresponding loan was deemed to have been made under the DIP Facility.

The Canadian court approved the Final DIP Facility Order despite the roll-up. In reaching this conclusion, the Canadian court considered the following facts:

1. the motion was for recognition of an order made in a foreign main proceeding;
2. the US Court had found that there was good cause to approve the Final DIP Facility Order despite hearing certain objections to it;
3. the Final DIP Facility Order was supported by the Unsecured Creditors’ Committee; and
4. the Canadian unsecured creditors would be treated no less favourably than US unsecured creditors.

One of the most significant factors in the decision was the fact that the order had been granted by the US Court in a foreign main proceeding.

After noting the prohibition on roll-ups in s. 11.2 of the CCAA, the Canadian court observed that s. 49 of the CCAA permits a Canadian court to make any order that it considers appropriate when recognizing an order of a foreign court, provided that the Canadian court is satisfied that the order is necessary for the protection of the interests of the debtor, a creditor or creditors.

The Canadian court also noted that s. 61(2) of the CCAA permits the Canadian court to refuse to recognize the orders of a foreign court where doing so would be contrary to public policy. The Canadian court decided that s. 61(2) of the CCAA should be interpreted restrictively, in light of the Guide to Enactment of the UNCITRAL Model Law on Cross-Border Insolvency. The Canadian court relied on the report of the Information Officer which it had appointed, which stated that there would be no material prejudice to Canadian creditors if the Canadian court recognized the Final DIP Facility Order, and that nothing was being done that was contrary to the applicable provisions of the CCAA. The Canadian court therefore found that the Final DIP Facility Order did not raise any public policies issues and recognized the Final DIP Facility Order.

It could be argued that the roll-up of Hartford’s pre-petition debt provided for in the Final DIP Facility Order was only a roll-up in theory, and not a roll-up in fact. The Canadian court observed that the cash collateral on hand as of the date of the Chapter 11 petition was effectively spent during the Chapter 11 proceedings and replaced with advances under the DIP Loan, so that all of the cash collateral available as of the date of the Final DIP Facility Order was cash advanced by the DIP Loan lender.

Co-operation Between Courts in Cross-Border Insolvencies

This case provides a window into the distinction between the orders that are available in a plenary case under the CCAA compared with the orders that can be recognized under Part IV. Clearly, the Canadian courts are very sensitive to the need for close cooperation between the US and Canadian courts in cross border insolvency matters.

Nominee Directors in Canada

Canadian law relating to corporate directors’ duties differs from U.S. law. In particular, the directors’ fiduciary duty requires a director to act in the best interests of the corporation. This duty does not change when the corporation is in the “vicinity of insolvency”. In particular, the directors’ duty remains with the corporation and does not shift to creditors. Further, a director has a positive obligation to share third party information, including confidential information, with the corporation if the information affects the corporation in a vital aspect of its business. Nominee directors are subject to the same fiduciary duty as any other director. They may not prefer the interests of their nominators and their duties to the corporation are not attenuated in any way. We also note that a number of federal and provincial statutes impose personal liability on directors to pay certain amounts if a corporation becomes insolvent and cannot pay the amounts.

Minimizing the Risk

• Resign – In the context of a creditor appointed director in a debt restructuring, resignation may be more readily considered than in other circumstances. Resignation as a director will avoid allegations of misuse of confidential information, non-disclosure and conflict of interest based on subsequent events. However, resignation will not excuse the nominee from obligations incurred as a director before resignation.
• Don’t Participate in the Restructuring (Place a “Cone” Over the Nominee) – If nominee directors do not resign, the creditor should consider placing a “cone” over its nominees to provide insulation from information and decision-making relating to the creditor’s restructuring efforts. The objective of the cone is to facilitate the nominee directors complying with their fiduciary obligations. If the director is not involved in the restructuring efforts, the director will not be sharing information with or acquiring information from the creditor in a manner that could be criticized as inconsistent with their duties as a corporate director. Nor will the nominee be making decisions about the restructuring that could be perceived as conflicting with the interests of the corporate borrower.
• If the Nominees Participate, Demonstrate Compliance – If nominee directors do not resign and participate in the creditor’s restructuring efforts, the directors should take care to act in a way that demonstrates compliance with their duties as directors. It is not possible to produce an exhaustive list of behaviours because the situation would be an evolving one. However, examples of the types of behaviour the director should exhibit include the following:
  • Nominee directors should always be clear about whether they are acting in their capacity as a director of the corporation or as an employee of the creditor. In particular, restructuring discussions among a nominee and the corporation should clearly be conducted in the nominee’s capacity as an employee of the creditor.
  • Nominee directors should clarify their authority to share information regarding the corporate borrower with the creditor, even where such sharing is authorized in the applicable loan documentation
  • If the board of the borrower is addressing issues relating to the loan, Canadian business corporations statutes require nominees to disclose a conflict of interest and to refrain from attending at board discussions about, or voting on, the issues. Depending on the nature of more general restructuring discussions, it may also be prudent for the nominee director to simply recuse themselves.
  • The nominee director should continue to seek legal advice about their duties throughout the process. Some business corporations statutes do not recognize an expert reliance defence in connection with breach of a director’s fiduciary duty, but expert advice may nevertheless help a director avoid an obvious misstep.
     

Please note that each circumstance will have its own particular facts and issues and that counsel should be conducted before proceeding. We would be happy to assist you in this regard. Also, the above summary focuses on laws in the Province of Ontario. Different rules may apply in some of the other Provinces

This case is of particular interest to lenders due to the outcome of the priority contest over a reserve fund consisting of proceeds from a sale of the business assets of the debtor and its affiliates.  The Court found that payments for the full deficiency of underfunded defined benefit pension plans had priority over the holder of a court ordered debtor-in-possession charge (ie. a secured creditor). 

See the Update for a full discussion.