In Re Crystallex, 2012 ONCA 404, the Ontario Court of Appeal unanimously upheld unusually broad DIP financing arrangements granted pursuant to section 11.2 of the Canadian Companies' Creditors Arrangement Act (CCAA) despite the vociferous objections of substantially all of Crystallex’s creditors. By dismissing the appeal, the Court endorsed the supervising CCAA judge’s approval of:
- DIP financing in the amount of $36 million which was secured by a court ordered charge, extended for approximately three years, would convert and continue as exit financing after Crystallex emerged from CCAA protection (if ever) and cause fundamental changes to Crystallex’s governance and capital structure; and
- a management incentive plan that conveyed “exceptionally large amounts” of Crystallex’s potential value to key executives to pursue Crystallex’s sole asset – arbitration of a claim against the government of Venezuela for US $3.4 billion,
all without requiring approval by Crystallex’s creditors.
In reaching these conclusions, the Court of Appeal declined to substitute its own views for that of the supervising judge and reaffirmed the great flexibility and discretion that section 11.2 of CCAA gives to a supervising CCAA judge to approve so-called ‘interim’ financing. The Court also held that the recommendation of a debtor’s directors regarding interim financing under section 11.2 of the CCAA is not entitled to deference but the recommendation of a debtor’s independent directors regarding a management incentive plan may be entitled to some weight.
Crystallex’s most significant liability is its debt owed under $100 million of defaulted notes that matured on December 23, 2011. The holders of the notes have a veto over any plan that Crystallex may propose to its creditors under the CCAA. The relationship between Crystallex and the holders of those notes was and continues to be hostile.
After failing to refinance or extend the notes, on December 23, 2011, Crystallex was granted CCAA protection over the objection of the holders of the notes (who proposed their own competing CCAA filing and plan for Crystallex). Among other things, Crystallex was permitted to: (i) file a plan of compromise and arrangement; (ii) continue to pursue the arbitration against the government of Venezuela; and (iii) pursue all avenues of ‘interim’ financing, including by conducting an auction for DIP financing.
DIP Financing Auction
The auction for the interim financing proved to be the most contentious point as existing participants in Crystallex’s capital structure were precluded from participating in the DIP financing auction unless they signed a standstill agreement that essentially stripped them of their ability to fully participate in Crystallex’s CCAA proceedings to protect their rights as pre-filing creditors.
During the auction, a third party financier offered $36 million repayable in December 2016 to be advanced in tranches. Once the second tranche was advanced, the financier became entitled to: a) 35% of the net proceeds of the arbitration (if any) in addition to interest; b) governance rights that would continue after Crystallex exited from CCAA protection (if ever); and c) approval rights for a range of items that would customarily be offered to creditors seeking to negotiate a plan of compromise or arrangement.
Regardless of their exclusion from the interim financing auction process (and without signing the standstill agreement), the holders of over 75% of the notes proposed a DIP loan of $10 million with simple interest at the rate of 1%, repayable in October 2012 – essentially agreeing to provide low cost interim financing without requiring fundamental changes to Crystallex’s governance and capital structures. The holders offered financing to allow Crystallex sufficient time to prepare and propose a CCAA plan of arrangement to its creditors and continue the arbitration.
Crystallex chose to seek approval of the third party financing bid alleging that it could not be assured additional funds would be available from the note holders on the same terms to finance the arbitration after the note holders’ proposed DIP financing expired in October 2012. In essence, the third party financing appears to permit Crystallex to avoid dealing with its creditors until after the arbitration had been completed (presumably in the speculative hope that it could pay the notes in full and avoid having to propose a plan over which the holders of the notes had a veto). That said, the CCAA court accepted Crystallex’s submission that it intended to propose a CCAA plan to its creditors within a few months and so determined that the length of time that Crystallex would be under CCAA protection was not a determinative factor.
In the appeal, the Court addressed both the standard of review for an appellate court and the scope of ‘interim’ financing a CCAA court can or should approve while a company is under CCAA protection, including whether and when it is appropriate for a CCAA court, without the approval of affected creditors, to approve financing that may continue for a significant time after CCAA protection ends. The Ontario Court of Appeal referenced the “unique facts of this case” and concluded it had no basis upon which to interfere with the supervising CCAA judge’s exercise of discretion to approve the interim financing. In doing so, the Court:
- Reiterated that the standard of review in appeals for a discretionary CCAA order is confined to an error in principle, an unreasonable exercise of discretion, a failure to consider appropriate factors or the correctness, in the legal sense, of the conclusion.
- Reiterated that the CCAA gives courts broad discretionary powers. Although this discretion must further the underlying spirit and remedial purpose of the CCAA, the discretion is broad enough to permit a supervising judge to make any order appropriate to the circumstances. This discretion supported the supervising judge’s exercise of discretion to authorize the ‘interim’ financing auction process and the third party financing.
- Held that section 11.2 of the CCAA contemplates the grant of a charge, the primary purpose of which is to secure financing required by the debtor during the expected duration of its CCAA proceedings. The Court went on to say, however, that a further purpose of section 11.2 interim financing is to enhance the prospects of a plan of compromise or arrangement that will lead to a continuation of the company in a restructured form or plan approval. Although section 11.2(4)(a) requires the court to consider the period for which CCAA protection will be in place, it does not require that such protection actually be in place for the duration of court ordered financing. Thus section 11.2 permitted ‘interim’ financing to be ordered that extended beyond the period of CCAA protection, without creditor approval. The Court did note, however, that it would be unusual for a CCAA court to approve exit financing where opposed by substantially all of a debtor’s creditors, as exit financing is often a key element or a pre-requisite of a plan voted on by creditors.
- Determined that as the terms of the DIP financing did not compromise the debt owed under the notes or take away the legal rights of the note holders it did not amount to a compromise or arrangement which required a creditor vote.
- Placed great weight on the supervising judge’s findings that there would be no recovery and no restructuring without financing the Venezuelan arbitration and that Crystallex intended to propose a CCAA plan to its creditors within a few months.
- Held that the recommendation of a debtor’s directors regarding interim financing under section 11.2 is not entitled to deference as an exercise of business judgment. Instead, the supervising CCAA judge must make an independent determination of whether an order under section 11.2 is appropriate.
- Held that the recommendation of a debtor’s independent directors (having obtained independent expert advice) about a management incentive plan is entitled to some weight, especially when those directors received expert advice, because the CCAA does not list the specific factors the court must consider in that regard and the directors would have the best sense of which employees were essential to the restructuring efforts.
The decision of the Ontario Court of Appeal in Crystallex highlights the limits of appellate review and the great flexibility that section 11.2 of CCAA gives to a supervising CCAA judge to grant so-called ‘interim’ financing. The facts of each case viewed in light of the criteria set out in section 11.2 and the broad discretion afforded a supervising CCAA judge will determine the types of financing arrangements that may be approved prior to creditors approving a CCAA plan.
That said, it is not clear that the decision in Crystallex furthers the overarching purpose of the CCAA to facilitate a compromise between a company and its creditors when longer term financing (potentially extending beyond the duration of the arbitration and the CCAA stay) and a management incentive plan were secured on extraordinary terms to pursue a speculative prospect without creditor approval. The CCAA has been viewed historically as providing a limited period of ‘breathing room’ so a debtor could make an arrangement with its creditors within a reasonable period of time, not forestall the debtor making a proposal to creditors by extraordinary means to preserve speculative value for management, shareholders or strangers to the capital structure.
It is also not clear how the purpose and structure of the DIP financing in Crystallex coincides with the relevant provisions of the CCAA and prior case law dealing with DIP financing: a) that is intended to be ‘interim’, ‘lights on’ and ‘facilitative to a restructuring plan’; and b) where that DIP financing has aspects that are strikingly similar to those typically contained in a CCAA plan without a vote of approval from affected creditors.
It was open to Crystallex throughout to propose an acceptable sharing of the spoils of the Venezuelan arbitration to its creditors as the basis for a CCAA plan and funding of future arbitration efforts, and so there could have been a restructuring for existing participants in the capital structure well in advance of recovery on the arbitration. Crystallex chose instead to pursue a court ordered DIP financing process that, so far, among other aspects, has had the effect of:
- potentially delaying creditor rights well beyond periods of delay consistent with prior CCAA cases;
- providing extraordinary potential value to those participating in a management incentive program and a stranger to the capital structure; and
- preserving potential value for shareholders while Crystallex is insolvent and subject to a statute that stipulates shareholders are not to vote or be paid until creditors are paid in full.
We understand that the note holders are seeking leave to appeal to the Supreme Court of Canada, and the Court has expedited the leave application.