The Ontario Superior Court of Justice has recently re-confirmed that a debtor subject to proceedings under the Companies' Creditors Arrangement Act (the "CCAA") may be authorized to pay pre-filing obligations owed to a critical supplier. In Re Northstar Aerospace, Inc.1 ("Northstar") the court authorized payment of pre-filing obligations owed to a critical supplier located in China, even though that supplier was subject to an order under section 11.4 of the CCAA compelling it to continue to supply goods post-filing. Northstar reaffirms cases decided prior to the amendments made to the CCAA in 2009, and confirms decisions made after the coming into force of the amendments that found that the CCAA court continues to have jurisdiction to authorize payment of pre-filing obligations to critical suppliers in certain circumstances.

In a CCAA proceeding, the general rule is that all unsecured pre-filing claims against the debtor company should be paid on a pari passu basis. Any payments made to only one creditor or a select group of unsecured creditors on account of pre-filing obligations may be found to be an improper preference.

An exception may be available where a critical supplier refuses to continue to supply goods or services unless it is paid its pre-filing invoices, and where the supplier is located outside the jurisdiction of Canadian courts. As a practical matter, attempting to enforce an order against a critical supplier in certain foreign jurisdictions could be unfeasible, cause undue delay that interrupts business operations, and jeopardize the debtor's ability to restructure. In these situations, pre-amendment case law suggests that it is open to the courts to authorize the payment of pre-filing obligations in order to ensure the uninterrupted operation of the debtor company during the restructuring. The Court in Northstar considered whether this jurisdiction was ousted with the enactment of section 11.4 of the CCAA in 2009. Section 11.4 gives courts the power to compel a critical supplier to supply on terms the court considers appropriate, in exchange for the benefit of a court ordered charge over collateral to secure payment of invoices related to supply of goods and services post-filing.

Northstar filed for CCAA protection, and was attempting to close a transaction for the sale of certain Canadian assets (the "Heligear Transaction"). A supplier located within the People's Republic of China ("Changsha") rendered two invoices prior to the date of the initial order made under the CCAA, and refused to supply any further parts until these invoices were paid. Changsha was subject to the critical supplier provisions within the initial order compelling the identified critical vendors to supply in exchange for a charge over the assets. Notwithstanding this protection for payment of its post-filing invoices, Changsha refused to supply unless its pre-filing invoices were paid. Given the circumstances, Northstar chose to bring a motion for court approval to have the two invoices paid immediately.

The court in this case affirmed its jurisdiction to permit payment of pre-filing obligations to creditors whose goods or services are critical to the ongoing operations of a debtor company.2 The court stated that this power is not ousted by section 11.4 of the CCAA, and that it is within the court's discretion. The court recited a number of factors considered by courts in the past when determining whether it is appropriate to authorize the payment of pre-filing payables:

  1. Whether the goods and services are integral to the business of the debtor company;
  2. The debtor company's dependency on the uninterrupted supply of the goods/services;
  3. The fact that no payments would be made without the consent of the Monitor;
  4. The Monitor's support and willingness to work with the debtor company to ensure that payments to suppliers in respect of pre-filing liabilities are minimized;
  5. Whether the debtor company has sufficient inventory of the goods on hand to meet their needs; and
  6. The effect on the debtor company's ongoing operations and ability to restructure if they are unable to make pre-filing payments to their critical suppliers.3

There were various facts in Northstar that favoured the payment of the pre-filing obligations rather than the debtor attempting to enforce an order under section 11.4 of the CCAA against Changsha:

  1. The time sensitive nature of the Heligear Transaction, and the direct link between the supplies provided by Changsha to the closing of that transaction;
  2. The lack of sufficient inventory and the inability of Northstar to find a suitable replacement for Changsha within a reasonable amount of time;
  3. The potential of imminently affecting the production lines of a customer, General Electric; and
  4. The location of Changsha outside the geographical jurisdiction of Canadian courts, making it difficult to enforcement of any order against them in a timely fashion.

The court therefore authorized the pre-filing payments to Changsha due to practical realities even though, in the words of the court, such an outcome "in a sense, rewards improper conduct by a critical supplier who has ignored an order of this court and has the effect of countenancing a form of hard-ball queue-jumping."

Companies planning potential reorganization proceedings should carefully assess which suppliers are critical to their operations, whether sufficient inventory banks are available, whether alternative or dual sources of supply are available, and whether cash plans take into account the possibility that pre-filing payments to certain critical suppliers may need to be made, particularly critical suppliers located in jurisdictions outside of Canada that have no offices or assets in Canada.