The Ontario Court of Appeal (OCA) has closed the door on the application of equitable subordination in Companies’ Creditors Arrangement Act (CCAA) proceedings. In U.S. Steel Canada Inc. (Re), the OCA clarified the scope of the court’s broad discretion under section 11 of the CCAA and found that the American doctrine of equitable subordination — which allows for the re-ranking of creditor claims in the face of inequitable conduct by higher-priority creditors — does not further the remedial purpose of the CCAA and, therefore, should not be applied.
Blakes acted as counsel for the respondent, United States Steel Corporation (USS).
U.S. Steel Canada Inc. (USSC) was formed following the acquisition and reorganization of Stelco by United States Steel Corporation (USS) in 2007. After several years of operation, USSC entered creditor protection under the CCAA in September 2014. The CCAA is a federal statute that provides protection to insolvent corporations, allowing them to strike a compromise or arrangement with creditors and to continue as a going concern.
As part of the USSC CCAA proceedings, USS advanced creditor claims against USSC for approximately C$2.2-billion.
Other creditors in the CCAA proceeding (Objectors) objected to USS’s claims on multiple grounds, including on the basis that USS’s claims should be subordinated pursuant to the doctrine of equitable subordination.
Equitable subordination is a doctrine of American insolvency law that allows a court to subordinate a creditor’s claim in favour of other creditors where the high-ranking creditor has acted inequitably. Despite its long history in the United States, equitable subordination has never been applied in a CCAA proceeding in Canada. The Supreme Court of Canada (SCC) has twice declined to confirm its applicability in Canada in general, including under the CCAA or the Bankruptcy and Insolvency Act (BIA). Parliament has never amended either act to allow for equitable subordination, even though it has been codified in the U.S. Bankruptcy Code since 1978.
The Objectors asserted that if they were able to prove inequitable conduct on the part of USS, the court had the power to subordinate USS’s debt claims under section 11 of the CCAA. Section 11 grants the court power to “make any order it considers appropriate in the circumstances”. This power is “subject to the restrictions set out” in the CCAA.
On a motion to determine if and how the objections would proceed, the CCAA judge found that section 11 of the CCAA would not give him jurisdiction to apply the doctrine of equitable subordination. In making this decision, the CCAA judge noted that the SCC had effectively rejected the doctrine by twice declining to adopt it. The CCAA judge further found that the CCAA already had mechanisms for re-ranking creditors’ claims and that these provisions acted as a “restriction” within the meaning of section 11, which thereby prevented the court from re-ranking claims based on equitable considerations. In this respect, the CCAA judge found that when Parliament amended the CCAA in 2009 to provide additional re-ranking mechanisms, it could have allowed for re-ranking based on equitable subordination. He found that Parliament chose not to do so and, as such, the court must respect that decision.
The Objectors also sought to challenge USS’s claims relying on the re-ranking mechanisms that the CCAA judge found to exist within the CCAA, including by alleging that the certain debt claims were properly equity and that certain claims should be invalidated due to lack of consideration or as a fraudulent preference. On February 29, 2016, the CCAA judge dismissed these objections, as discussed in our March 2016 Blakes Bulletin: Ontario Court Addresses Debt Re-Characterization Argument in CCAA Proceeding.
The OCA upheld the CCAA judge’s decision regarding equitable subordination, but for different reasons. The OCA disagreed that the CCAA and its legislative history restricted the application of equitable subordination. The OCA, instead, focused on the language of section 11 that requires any order made under section to be “appropriate in the circumstances”.
The OCA found, as a matter of statutory interpretation, that the words “appropriate in the circumstances” must be interpreted in harmony with the purpose of the CCAA. The purpose of the CCAA is to facilitate compromise or arrangements between companies and their creditors. Accordingly, the OCA found that any order made under section 11 must further this remedial purpose.
With this in mind, the OCA explained that that the CCAA does not contain implied or express authority to apply the doctrine of equitable subordination. Further, the OCA found, that equitable subordination does not fall within the broader scheme of the CCAA, as the CCAA’s purpose is not to create a scheme of priorities for distribution. Such priorities, the court continued, are to be worked out as part of a compromise or arrangement. After noting that the appellant had not raised any arguments as to how equitable subordination would further the CCAA’s purpose, the OCA also referred to the SCC’s decision in Sun Indalex Finance, LLC v. United Steelworkers. There, the SCC cautioned courts from deploying equitable remedies to do what they wish Parliament had done through legislation. Finally, the OCA found that there was no “gap” in the legislative scheme to be filled by equitable subordination through the exercise of discretion, the common law, the court’s inherent jurisdiction or by equitable principles.
Although the OCA appears to have excluded equitable subordination from applying in future CCAA proceedings, it did leave the door open for the doctrine to be applied in BIA proceedings. Specifically, it noted that courts have broader jurisdiction under the BIA to grant a remedy such as equitable subordination, as well as a legislative purpose more relevant to the potential reordering of creditor priorities.
The OCA’s decision has two important implications.
First, it provides some comfort to CCAA participants that a compromise or arrangement will not be hindered or delayed by pending judicial determinations on equitable subordination. Litigating such claims within a CCAA proceeding would likely require intensive and lengthy discovery followed by extensive evidentiary hearings.
Second, the OCA clarified that the CCAA section 11 analysis requires the court to determine whether the order being requested furthers the CCAA’s remedial purpose, which is to facilitate a compromise or arrangement. Where a requested order does not further this purpose, the order will not be “appropriate in the circumstances” for the purpose of section 11.