This article is an extract from The Restructuring Review, 14th Edition
Overview of restructuring and insolvency activity
In 2020, the covid-19 pandemic created significant disruption to daily life in Canada as in other parts of the world. Every sector of the Canadian economy has been affected, with some sectors, such as travel and hospitality, and retail services, being particularly hard hit. Despite difficult economic conditions, there was a 29.5 per cent decrease in insolvency filings from 2019, representing the largest annual decrease ever recorded.2 The number of consumer and business insolvency filings decreased by 29.7 per cent and 24.3 per cent, respectively.3 The decrease is largely attributable to government financial support, such as the Canada Emergency Response Benefit for individuals and the Canada Emergency Wage Subsidy for businesses, and deferrals of debt payments during the pandemic.
While uncertainty remains elevated regarding the end of the pandemic, the Bank of Canada found that the Canadian economy showed resilience during the pandemic and is projecting a favourable economic outlook through 2021 and into 2022.4
Recent legal developmentsi 9354-9186 Québec Inc v. Callidus Capital Corp, 2020 SCC 10
In early 2020, the Supreme Court of Canada issued an important decision regarding both the powers and discretion of CCAA supervising judges to enforce the requirement that parties act in good faith and confirming that litigation funding is an acceptable form of interim financing in insolvency proceedings.
Bluberi Gaming Technologies Inc (Bluberi) manufactured electronic casino gaming machines. In 2012, Bluberi sought and received financing in the amount of C$24 million from Callidus Capital Corporation (Callidus). Bluberi lost significant amounts of money over the following three years, and Callidus continued to extend credit. By 2015, Bluberi owed Callidus approximately C$86 million. Bluberi claimed that Callidus, as a secured creditor, took de facto control of the business to deplete its value, with the eventual goal of purchasing Bluberi.
In 2015, Bluberi obtained CCAA protection and determined, along with the court-appointed monitor, that an asset sale was necessary. The supervising judge approved a sale in early 2016, over Callidus's objection. Bluberi and Callidus then entered into an asset purchase agreement. Callidus obtained all of Bluberi's assets in exchange for extinguishing almost all of its secured claims against Bluberi. The agreement also allowed Bluberi to retain its claim for damages against Callidus for alleged involvement in causing the debtor's financial difficulties.
In 2017, Bluberi filed a motion seeking approval of an interim financing credit facility to fund litigation against Callidus. However, the day before the motion hearing, Callidus proposed the first of two plans of arrangement. Bluberi's creditors were divided into two classes: unsecured creditors in one class, and Callidus as the sole secured creditor in the other. This first proposal failed to secure the required double majority within the unsecured creditors class (i.e. a majority of unsecured creditors holding two-thirds of the value of the class members' claims).
In 2018, Bluberi filed an application to authorise a third-party litigation funding agreement to pursue its claims against Callidus. A few days later, Callidus proposed its second plan of arrangement. This second proposed arrangement was nearly identical to the first. However, before voting on the plan of arrangement, Callidus filed an amended proof of claim valuing its secured claims against Bluberi at nil.
The supervising judge approved Bluberi's third-party litigation agreement as interim financing pursuant to Section 11.2 of the CCAA, but refused to allow Callidus to vote with unsecured creditors because it was acting with an 'improper purpose'. The Quebec Court of Appeal reversed the supervising judge's decision.
The Supreme Court agreed with the supervising judge that Callidus should not be permitted to vote with the unsecured creditors' class. The Court reaffirmed that Section 11 of the CCAA granted a supervising judge broad discretion to 'make any order that it considers appropriate in the circumstances'. However, certain 'baseline considerations' must be met: the applicant must demonstrate that the order sought is appropriate in the circumstances, and that the applicant has been acting in good faith and with due diligence. Notably, the requirement of good faith conduct was recently codified as Section 18.6 of the CCAA.
Under the CCAA, there is no bar to creditors voting in their own interest. However, the court held that in this case the 'inescapable inference' was that Callidus had attempted to strategically 'circumvent the creditor democracy the CCAA protects'. The court concluded that the supervising judge rightfully barred Callidus from voting for the second proposal as an unsecured creditor because it was acting for an improper purpose. The court found that an improper purpose was any purpose collateral to the purpose of insolvency legislation, which in this case was Callidus' attempt to manipulate the creditors' vote to ensure that its second plan would succeed where its first plan had failed.ii Arrangement relatif à Nemaska Lithium Inc, 2020 QCCS 3218
In October 2020, the Quebec Superior Court granted a reverse vesting order under the CCAA. A reverse vesting order transfers undesirable assets and liabilities from the insolvent entity to a new company, typically incorporated specifically for the purpose. This was the first time a Canadian court granted an opposed reverse vesting order, as they had only previously been granted on consent of the parties.
The debtor companies, 'Nemaska entities', were involved in the development of a lithium mining project in Quebec. When lithium prices declined, they sought CCAA protection and a sales process was approved. A group of Nemaska's largest secured creditors then offered to purchase subject to a reverse vesting order.
Two shareholders of Nemaska entities (one of whom was also a creditor) objected to the issuance of the reverse vesting order on multiple grounds, including the impossibility under the CCAA for debtor companies to emerge from CCAA protection outside a compromise or arrangement as well as the court's lack of authority to grant a vesting order for anything other than a sale or disposition of assets.
The presiding judge dismissed these arguments, and held that the reverse vesting order meets the statutory criteria under the CCAA. The issuance of the reverse vesting order was a valid use of the discretion afforded to the supervising judge and in line with the CCAA's remedial objectives.8 The judge also noted the catastrophic impact other alternatives would have on all stakeholders and highlighted that CCAA generally prioritises 'avoiding the social and economic losses resulting from the liquidation of an insolvent company'.9
When approving any vesting order under the CCAA, the court must first assess: '1) whether sufficient efforts to get the best price have been made and whether the parties acted providently; 2) the efficacy and integrity of the process followed; 3) the interests of the parties; and 4) whether any unfairness resulted from the process'.10
This decision was appealed to the Quebec Court of Appeal and recently to the Supreme Court of Canada, but both courts denied leave to appeal.iii Petrowest Corporation v. Peace River Hydro Partners, 2020 BCCA 339
In November 2020, the BC Court of Appeal held that a receiver can enforce executory contracts of a debtor without being bound by the arbitration clauses contained in them.
Petrowest Corporation and its affiliates were placed into receivership. The receiver brought an action against Peace River Hydro Partners and its partners (Peace River), to recover amounts outstanding under various contracts. Peace River subsequently sought an order to stay the action under BC's Arbitration Act,11 because all disputes were subject to mandatory arbitration.
The BC Supreme Court rejected the application for a stay, allowing the receiver to proceed with the action. It reasoned that while BC's Arbitration Act applied, Section 183 of the BIA allowed the Court 'to control its own processes, including avoiding the operation of section 15(1) of the [Arbitration] Act'.12
On appeal, Peace River argued that the chambers judge had erred in her interpretation of Section 183 of the BIA and the receiver argued that she had erred in concluding that the Arbitration Act applied. The BC Court of Appeal dismissed the appeal, but concluded that the Arbitration Act did not apply in this case, because the action was not commenced by a 'party' to the arbitration agreements within the meaning of the provision. There is a fundamental distinction between a receiver or trustee and a debtor or bankrupt, as the former has the power to disclaim contracts entered into by the debtor or bankrupt.13 This is because, unlike the debtor or bankrupt, a receiver is an officer of the court and owes a fiduciary duty to realise proceeds for all stakeholders.14 In opting to commence this action, the receiver had, in effect, disclaimed the arbitration agreements entered into by the debtor and was not a 'party' to them. The arbitration agreements became 'void, inoperative or incapable of being performed'.15 Furthermore, arbitration agreements are treated as 'independent agreements' and can be separated from the main contract due to the doctrine of separability in Canada.16 Therefore, due to a receiver's particular powers and position, as well as the separability of the arbitration agreements, the receiver can sue to enforce the debtors' contracts while also disclaiming the arbitration clauses within them.
The Supreme Court has granted leave to appeal this decision.iv Groupe Dynamite Inc v. Deloitte Restructuring Inc 2021 QCCS 3
The Quebec Superior Court held that under the CCAA, the debtor was not relieved from paying post-filing rent for the premises it had not disclaimed, even though its ability to 'use' them had been severely limited by government-imposed covid-19 restrictions.
Groupe Dynamite Inc (Dynamite) operated several retail stores in Canada and suffered from covid-19 restrictions in Ontario and Manitoba. Dynamite, along with its US affiliates, had sought protection under the CCAA. The court order granting CCAA protection stated that no person who supplied goods, services or the 'use of leased property' to Dynamite after the order, could be prohibited from requiring immediate payment. This provision also closely mirrors Section 11.01(a) of the CCAA.17
Following the continued covid-19 restrictions, Dynamite applied to amend the court order arguing that it was not 'using' the premises during the lockdowns and should not be obligated to pay post-filing rent. The landlords objected, contending that as long as the leases were not disclaimed, Dynamite's occupation qualified as a 'use' of the premises.
The court dismissed Dynamite's application on the basis that it would violate Section 11.01(a) of the CCAA and the court cannot make orders contrary to the restrictions explicitly set out in the CCAA. It noted that for a debtor to make 'use' of the property within the meaning of Section 11.01(a), it need not carry on the original activity for which the property was leased. Despite Dynamite's inability to fully operate its business in the leased properties due to the covid-19 restrictions, it had not disclaimed the premises and continued to assert its right to 'sole possession'. The court noted that 'where leased premises are occupied by a debtor and cannot be leased to anyone else, the landlord is not prevented from demanding immediate payment of rent regardless of whether or not the debtor is carrying on business'.18v CWB Maxium Financial Inc v. 2026998 Alberta Ltd 2021 ABQB 137
The Alberta Court of Queen's Bench provided guidance on the duty of good faith required by the newly enacted Section 4.2 of the BIA. This section has two parts:
- any interested person in any proceeding under the BIA must act in good faith with respect to those proceedings; and
- if satisfied that an interested person failed to act in good faith, then on application by any interested person, the court may make any order that it considers appropriate in the circumstances.
The court made several key finding in this case. First, a secured creditor seeking a receivership order is an 'interested person' subject to the good faith requirement of Section 4.2. Second, the 'good faith' to be exhibited 'in respect of' BIA proceedings, encompasses not only the conduct in the course of such proceedings, but also the conduct that precipitated the proceedings, 'where that conduct is factually and temporally connected to the proceedings'.19 In this case, the secured creditors' conduct since the issuance of the first demand letters was when the prospect of receivership proceedings first materialised, and thus was relevant for the purposes of Section 4.2. Third, 'good faith' requires that a creditor not bring or conduct proceedings for an oblique motive or improper purpose; it requires parties not to lie to or mislead the other. However, it is not a fiduciary duty, and does not impose a duty of loyalty or disclosure, or require the subordination of one's own interests to the other.vi Chandos Construction Ltd v. Deloitte Restructuring Inc 2020 SCC 25
In October 2020, the Supreme Court of Canada affirmed the anti-deprivation rule and the effects-based test. The anti-deprivation rule is a long-established common law rule that prevents contractual provisions from frustrating the insolvency regime and maximises assets available for a trustee to pass to creditors.20 The anti-deprivation rule invalidates a contractual clause if it is triggered by bankruptcy or insolvency and if its effect is to remove value from the insolvent's estate that would otherwise be available to creditors.21
Chandos Construction Ltd (Chandos), a general contractor, entered into a subcontract with Capital Steel Inc (Capital Steel). The contract contained a provision where Capital Steel was to pay Chandos 10 per cent of the total contract price in the event Capital Steel became insolvent. Capital Steel filed for bankruptcy prior to completing its contract, and Chandos argued it was entitled to set off the costs it had incurred to complete Capital Steel's work on the project and 10 per cent of the contract price as per the agreement. Furthermore, Chandos submitted that the effects-based test of the anti-deprivation rule should be substituted by the purpose-based test adopted by UK courts.22 The application judge found the provision was enforceable, but the Court of Appeal reversed the decision.
In an 8-1 decision, the Supreme Court rejected the UK purpose-based test and affirmed that the anti-deprivation rule renders void provisions that remove value otherwise available to an insolvent person's creditors. The Supreme Court, however, noted that provisions that eliminate a property from the estate but not value, or provisions whose effect is triggered by an event other than bankruptcy or insolvency, may not offend the anti-deprivation rule. Moreover, where commercial parties protect themselves against a contracting counterparty's insolvency by taking security, acquiring insurance or requiring a third-party guarantee, the anti-deprivation rule is not offended.23vii Legislative reforms
On 1 November 2019, reforms to Canada's BIA and CCAA came into force. These reforms aimed at improving the consistency and transparency of the insolvency regime and enhancing protections for workers and pensioners. There were no further legislative reforms in 2020.
Significant transactions, key developments and most active industriesi Significant transactions
The covid-19 pandemic has had a significant impact on many businesses, including Cirque du Soleil Entertainment Group, an international, Montreal-based live entertainment producer. After being forced to cancel shows around the world, Cirque du Soleil filed for bankruptcy under the CCAA in June 2020. The pandemic hit the company just as it finished a series of acquisitions, and it was forced to lay off 95 per cent of its workforce.24 The Superior Court of Québec granted Cirque du Soleil's application for CCAA protection.25 Cirque du Soleil entered into a 'stalking horse' purchase agreement with a group of its existing first lien and second lien secured lenders pursuant to which the lenders would acquire substantially all of the company's assets.26 In November 2020, Cirque du Soleil emerged from creditor protection under the CCAA, following a successful transaction with its secured lenders.27ii Key developmentsEmergence of litigation financing in Canada
Litigation financing agreements (LFA) are relatively novel in Canadian restructuring practice. Despite being widely used in Australia, the United States and the United Kingdom, these funding agreements are still relatively uncommon in Canada. However, Canadian courts will allow LFAs, provided they do not overreach or interfere with the lawyer–client relationship or the administration of justice. As described above, in Callidus, the Supreme Court of Canada confirmed that LFAs are appropriate in the context of insolvency proceedings.
LFAs in a restructuring context originated from Crystallex and Strateco.28 In Crystallex, the court considered whether the CCAA allowed a judge to approve financing that would continue significantly outside the period of CCAA protection, without approval from the creditors. The case dealt with an interim financing through a specialised lender that was to be used to finance litigation in exchange for the lender receiving 35 per cent of the litigation proceeds. In Strateco, the court evaluated another interim financing under the CCAA, which was intended to guarantee legal fees for the prosecution of a claim against the government that constituted the debtor's principal asset. In both cases, the pending litigation was the best chance at recovering any value for the creditors from the insolvent assets and the courts relied on a liberal and purposive interpretation of the CCAA in finding that the financing agreements were in the interest of the creditors. These two cases laid the foundation for Callidus, which is the latest in a string of LFA-type cases in the context of CCAA restructurings.
In Callidus, the court reaffirmed that the supervising judge appropriately considered that the LFA was fair and reasonable. In particular, he considered terms upon which lawyers would be paid, the risks and investments of the funder, and the extent of the funder's control of the litigation. The court reaffirmed the supervising judge's findings that the agreement was appropriate.
However, the court rejected an argument that the LFA was in reality a plan of arrangement that must be put to a creditors' vote. Without fully defining a plan of arrangement, the court held that there must be some compromise of creditors' rights for a proposal to amount to an 'arrangement' requiring creditor approval. The proposed LFA did not impact creditors' rights and could therefore be court-approved as interim financing pursuant to section 11.2 of the CCAA.OSB omnibus motion
At the beginning of the pandemic-induced shutdown in Canada, the Office of the Superintendent of Bankruptcy obtained an omnibus order that applied to the deadlines in all bankruptcy proceedings. It established a suspension period from the date of the order to 30 June 2020 to relieve pressure on stakeholders and the insolvency system due to covid-19.29Popularity of reverse vesting orders in 2020
Reverse vesting orders have been employed in significant restructurings in 2020, including Cirque du Soleil and Nemaska Lithium. Unlike standard approval and vesting orders that transfer desirable assets of the debtor company to a purchaser in exchange for sale proceeds, a reverse vesting order transfers unwanted assets and liabilities to a newly incorporated, non-operating company. This allows the original debtor company to retain desirable assets, and its shares are sold to purchaser free and clear of all the unwanted liabilities (by way of share purchase agreements rather than asset sale agreement). A significant benefit of a reverse vesting order is that the original company's existing rights such as permits, licences, tax attributes and essential contracts are all preserved. Reverse vesting orders are therefore very attractive for distressed companies that operate in highly regulated industries or companies that own undesirable and difficult-to-transfer assets. It is also an effective alternative to a plan of arrangement, both in terms of time and cost, taking place without a vote of creditors. At the end, the original debtor emerges from CCAA proceedings while the newly created residual company becomes subject to the CCAA.iii Most active and distressed industries
The hardest hit sectors in 2020 were those most adversely affected by the pandemic: arts, entertainment and recreation (+50 per cent or 39 filings); management of companies and enterprises (+14.3 per cent or 12 filings); educational services (+18.2 per cent or six filings); and public administration (+3 filings). The three sectors that experienced the largest decrease in the number of insolvencies were construction; manufacturing; and professional, scientific and technical services.30