Debtor-in-possession lending charge: when a super-priority charge is not so super

Facts
Ontario Superior Court of Justice judgment
Ontario Court of Appeal judgment
Resultant issues

Recently, the Ontario Court of Appeal released its decision in Indalex Limited.(1) The court ordered that certain reserved proceeds from the sale of the Canadian Indalex entities, held by FTI Consulting Inc (the monitor) in the context of cross-border proceedings under both the Companies' Creditors Arrangement Act (Canada) and Chapter 11 of the US Bankruptcy Code, be used to satisfy the deficiencies in two Indalex Canada pension plans in priority to the holder of court-ordered priority secured claims.

Facts

On March 20 2009 the US Indalex entities sought and obtained protection under the code before the US Bankruptcy Court for the District of Delaware. On April 3 2009 Indalex Canada obtained an order of the Ontario Superior Court of Justice granting it protection from creditors under the Companies' Creditors Arrangement Act. On April 8 2009 the court amended the initial order authorising Indalex Canada to borrow funds from a syndicate of lenders - collectively termed the debtor-in-possession (DIP) lenders. JP Morgan Chase Bank NA acted as administrative agent for the DIP lenders. The order gave the DIP lenders a 'super-priority' charge on all of Indalex Canada's property. In connection with the DIP loan agreement, Indalex US guaranteed Indalex Canada's obligation to repay the DIP lenders.

On July 20 2009 the Indalex Group obtained orders from the courts approving the sale of the Indalex Group assets. In attendance at the Canadian sale approval hearing were, among others, the United Steelworkers and a group of retired executives. The United Steelworkers consented to the sale, but the represented executives objected to it. Both the United Steelworkers and the represented executives made submissions that they were not in agreement with an immediate full distribution of the sales proceeds to the DIP lenders. Although the courts approved the sale, the monitor retained C$6.75 million in reserve, pending resolution of the claims made by the objecting stakeholders.

The purchase price allocated to the Indalex Canada assets, net of post-closing adjustments, was insufficient to repay the indebtedness owing by Indalex Canada to the DIP lenders. JP Morgan Chase Bank - acting as the DIP agent - called on the guarantee in respect of a shortfall of approximately US$10.75 million granted to it by Indalex US. Indalex US was subrogated to the DIP charge after it paid out on the shortfall to the DIP lenders.

One of Indalex Canada's pension plans, that being for the benefit of the salaried employees containing both defined benefit and defined contribution components, was already in the process of being wound up pursuant to the Pension Benefits Act (Ontario) before the Companies' Creditors Arrangement Act proceedings had commenced. The second pension plan, being a defined benefit plan for retired executives, did not begin its winding-up process until after the closing of the sale transaction. Both pension plans were underfunded. The purchaser assumed no responsibility for liability under either of the pension plans.

Ontario Superior Court of Justice judgment

The Ontario Superior Court of Justice later ruled that neither plan's beneficiaries were the beneficiaries of a deemed trust pursuant to the Pension Benefits Act which would take priority over the DIP charge. Specifically, the court dismissed the motion in respect of the executive plan on the basis that since the winding-up of the executive plan had not yet taken place, there was no deficiency in such plan as of the closing of the sale transaction. In respect of the salaried plan, the court indicated that since Indalex Canada was permitted by the regulations to the Pension Benefits Act to make up the deficiency in the salaried plan over a period of five years, the payments did not become due until they were required to be paid. Therefore, the court held that the reserve fund should be paid to Indalex US, as subrogee to the DIP charge.

Ontario Court of Appeal judgment

Pension Benefits Act (Ontario)
The Ontario Court of Appeal reversed the decision of the Ontario Superior Court of Justice. The court of appeal held that in the case of the salaried plan, the amount of the employer contributions that were required to be made (ie, accrued but not actually payable) had accrued as of the commencement of the winding-up of such plan. Thus, such amount was subject to a deemed trust pursuant to Section 57(4) of the Pension Benefits Act, even though it would, in the ordinary course, be payable in full over five years. The court of appeal cited Section 30(7) of the Ontario Personal Property Security Act, which provides that a security interest in accounts or inventory or proceeds therefrom (other than in respect of a purchase-money security interest) is subordinate to the claims of a beneficiary of a deemed trust under the Pension Benefits Act or the Ontario Employment Standards Act. The court of appeal held that the Pension Benefits Act deemed trust claim could not be eliminated, nor could its Personal Property Security Act imposed priority be reversed, by order of the Ontario Superior Court of Justice, unless such court had expressly ruled that the purpose of the Companies' Creditors Arrangement Act was paramount to both the Pension Benefits Act and the Personal Property Security Act. The court of appeal determined that in the absence of a paramountcy argument, the general DIP charge super-priority language found in the amended initial order was insufficient to give the DIP charge priority over the Pension Benefits Act deemed trust claim in respect of the salaried plan beneficiaries.

Fiduciary duties
The court of appeal held that as the administrator of the pension plans, Indalex Canada continued to be charged with the responsibility of administrating such pension plans during the Companies' Creditors Arrangement Act proceedings, and that it had breached its fiduciary duty as administrator - a duty which arose both under the Pension Benefits Act and at common law. The court of appeal found that Indalex Canada knew that the pension plans were underfunded and that pension entitlements would not be reduced unless additional funds were paid into the pension plans, but took no steps to correct the underfunding. Instead, the court of appeal indicated that Indalex Canada took a number of actions to prevent further funding of the pension plans, including:

• applying for Companies' Creditors Arrangement Act protection, and then for the DIP charge, both without notice to the pension plans' beneficiaries;
• entering into the sale transaction without providing or requiring payment to the pension plans;
• doing nothing in the Companies' Creditors Arrangement Act proceedings to fund the deficit in the underfunded pension plans;
• moving for an immediate distribution of the sale proceeds to the DIP lenders; and
• seeking, at the direction of Indalex US, to make a voluntary assignment in bankruptcy in order to defeat any deemed trust claims by the pension plans' beneficiaries.

The court of appeal held that Indalex Canada was in a conflict of interest position and that the appropriate equitable remedy was to impose a constructive trust on the reserve fund and pay such money to the beneficiaries of the pension plans. A major factor in the court of appeal's conclusion appears to be the finding that the subrogated secured creditor, Indalex US, was not acting at arm's length with Indalex Canada and, in fact, had shared management with Indalex Canada during the relevant time period in respect of the administration of the pension plans.

Since the breach of fiduciary duty finding was sufficient to order the reserve fund to be paid, in part, to satisfy the executive plan deficiency, the court of appeal declined to rule on the issue of whether the executive plan beneficiaries were also entitled to a secured deemed trust claim ranking above the DIP charge. The court of appeal determined that Indalex Canada should not be able to rely on its own inaction in winding up the executive plan to avoid the consequences that flow from a winding-up. Since the monitor confirmed shortly after the Canadian sale hearing that the executive plan would be wound up, the court of appeal postulated (without actually rendering a decision on the point) that if the deemed trust did not extend to the executive plan, such a result would be a triumph of form over substance.

Authorities reviewed by court of appeal
In its decision, the court of appeal referred to, among other authorities, the Ontario Superior Court of Justice's decisions in Ivaco(2) and Usarco,(3) the Ontario Court of Appeal decision in Ivaco(4) and the Supreme Court of Canada's decision in Century Services.(5) The court of appeal held that the Ivaco and Usarco decisions were of little assistance in deciding on the Pension Benefits Act deemed trust issues in the Indalex Canada matter. It held that such decisions included conflicting statements. Presumably, because the court of appeal (in the instant case) determined that in the Ivaco decision it did not expressly affirm the Ontario Superior Court of Justice's decision in Usarco (ie, that the Pension Benefits Act deemed trust is limited to regular contributions together with those special contributions which were to have been made but were not), it held that such cases were not determinative of the scope of the Pension Benefits Act Section 57(4) deemed trust.

The court of appeal also indicated that the Supreme Court of Canada's decision in Century Services does not stand for the unqualified proposition that federal priorities under the Bankruptcy and Insolvency Act (Canada) apply in Companies' Creditors Arrangement Act proceedings. Furthermore, both the Ontario Court of Appeal and the Ontario Superior Court of Justice expressed the view (without either court having to rule on the issue) that a debtor should not assign itself into bankruptcy to defeat priority claims arising under provincial legislation.

Resultant issues

As a result of the Ontario Court of Appeal decision in Indalex, the following issues might arise:

• Will companies that act as pension plan administrators seek to appoint an independent pension plan administrator before commencing Companies' Creditors Arrangement Act proceedings? Or will the striking of an independent committee with independent legal advice for the plan administrator's role suffice? Is either course of action practical in light of the other issues facing such an insolvent entity in the lead-up to a filing?
• Is the impact of this decision limited to situations involving court-ordered security such as DIP lending or will it affect other types of ordinary secured lending (eg, asset-based lending)?
• What will be the practical impact in respect of notice of Companies' Creditors Arrangement Act proceedings? Will Companies' Creditors Arrangement Act applicants be best suited to serve any stakeholder group that may benefit from any statutory trust or priority entitlement, even if such stakeholder group does not enjoy such entitlement as of the date of the filing under the act?
• Will secured lenders (whether DIP or otherwise) seek to reserve for the winding-up deficiency in respect of their borrower's defined benefit pension plans? If so, and considering the currency of pension solvency valuations (as opposed to winding-up reports), how will secured lenders monitor and calculate such deficiencies to ensure that the appropriate reserves are made?
• Will courts in Canadian insolvency proceedings resort to using the remedy of imposing a constructive trust in order to deal with perceived inequities in respect of the treatment of certain stakeholders?
• In light of the 2009 insolvency amendments that provide a priority entitlement in favour of pensioners in respect of all debtor property for the normal service costs, but not for the winding-up or solvency deficiencies in the context of a bankruptcy or a receivership, will the Ontario Court of Appeal's Indalex decision result in 'statute shopping', in that court-appointed receivership proceedings (with or without a resultant bankruptcy) may provide a more certain outcome to secured lenders than the filing of a Companies' Creditors Arrangement Act proceeding?
• When, if at all, will it be appropriate for a debtor to file an assignment in bankruptcy in order to bring about a re-ordering of creditor priorities?
• Has the Ontario Court of Appeal created a different class in respect of certain constituents (ie, unsecured creditors to which the debtor owes a fiduciary duty)?
• What will be the impact on the directors and officers of an entity that is considering filing for a Companies' Creditors Arrangement Act proceeding? Will they continue to act or will this type of issue cause them to resign sooner?

It is understood that the respondents at Ontario Court of Appeal level will be seeking leave to appeal to the Supreme Court of Canada. It may take a decision of the Supreme Court of Canada or appropriate statutory amendments to answer these and other questions that lenders, debtors and lending, pension and insolvency practitioners may have as a result of the Ontario Court of Appeal decision in Indalex.