I am tempted to draft a blog post listing the top ten ironies of bankruptcy law. There is no shortage of contenders for that list, and vying for the top spot would be the simple fact that you need a lot of money to go bankrupt. Bankruptcy (or its cousins, creditors arrangement and administration -- but not receivership, the economies of which could also feature in a blog post of its own) involves an influx of lawyers, accountants, and other professionals who negotiate and bicker their way through the company’s balance sheet, all while charging by the hour. To make certain that funds will be found to meet the costs of their efforts, the Court may segregate some of the company’s assets or cash at the beginning of the insolvency process. This special pool of cash can be called a “retention amount.” An “executive trust” or a “director’s trust,” if for the benefit of the company’s continuing management, serves much the same purpose.

The facts of a company’s demise often lead to the executives being participants, possibly as defendants, in litigation arising from the bankruptcy. This was the case in a very high-profile way in the insolvency of Nortel Networks. Nortel Networks is the subject of proceedings under the Companies’ Creditors Arrangement Act (the “CCAA”). Nortel itself had an obligation to indemnify its executives, as is usually the case if directors or officers are involved in litigation by virtue of their corporate role. Nortel’s insurers, Chartis Insurance Company of Canada, were therefore obliged to pay the executives’ legal fees. With a ten-million-dollar retention amount set aside in the Nortel bankruptcy proceedings, Chartis took the position that the executives should deplete that reserve, and an executives’ trust of $12 million, before turning to them for indemnification.  

Justice Morawetz of the Ontario Superior Court of Justice disagreed, finding that the trust indenture gave the trustees full discretion to permit access to the 12-million-dollar sum, and that requiring the retention amount to be emptied before turning to the insurance provision was to give Chartis priority over other, unsecured creditors. Although Nortel itself owed the indemnification duty to its executives, it could not actually pay them without breaching of the stay of proceedings inherent in the CCAA process. Therefore, as the payment by Nortel (who would access the retention amount to pay it) was not permitted, the insurance policy could be construed to require the insurer to pick up the slack. Chartis appealed. The Ontario Court of Appeal, in a decision released on August 15th, refused to grant leave to appeal that decision.

The test for leave of an order made in the course of CCAA proceedings is very high, as recently explored in the lawmaking Re Timminco Ltd. decision of the Court of Appeal in 2012. Leave may only be granted “sparingly” and in circumstances where “there are serious and arguable grounds of significant interest to the parties.” The Court of Appeal decided this was not a case in which that standard was met.  

The insurer’s position is understandable: they are not unsecured creditors, as was repeatedly suggested in obiter by the Courts in the Nortel matter, but rather contingent debtors to the company. If a pool of assets is sacrificed at the beginning of the process to cover the executives’ costs of carrying on, and part of carrying on is defending lawsuits, the pool of assets should possibly meet those costs. On the other hand, the insurers’ obligations are typically payable regardless of the financial health of the company, and Justice Morawetz’s legal reasoning on the effect of the CCAA stay (being that Nortel wasn’t permitted to pay) is sound.

The decision exposes the undergarments of the bankruptcy process: creditors have to accept that a liquidated pool of the company’s remaining assets will be set-aside for insolvency professionals; insurers are often the best deep-pockets available, but they may not pay willingly and may act like a party with an active stake in the eventual CCAA plan; and, despite the importance of orders made in a CCAA context, successful appeal is very unlikely.