On February 29, 2016, the Ontario Superior Court of Justice released a decision in the ongoing insolvency proceeding of U. S. Steel Canada Inc. (USSC). Two principal issues were addressed by the Court. First, whether amounts advanced by United States Steel Corporation (USS) to USSC (its indirect wholly-owned subsidiary) were properly characterized as debt obligations or “equity claims” under the Companies’ Creditors Arrangement Act (Canada) (CCAA). This distinction is important because under the CCAA regime “equity claims” rank lower in priority than debt claims. Second, the Court considered whether certain secured claims were unenforceable for lack of consideration or void as fraudulent preferences under section 95 of the Bankruptcy and Insolvency Act (Canada) (BIA).


The issue of debt re-characterization arose after USS sought approval of proofs of claim it filed in the CCAA proceeding, which exceeded C$2.2-billion. These claims were comprised primarily of amounts advanced by USS in connection with the acquisition of USSC in 2007 and advances to fund USSC’s post-acquisition working capital needs. A portion of USS’s claims were secured against the assets of USSC.

Certain stakeholders of USSC objected to the treatment of the USS claims as debt, asserting that such claims were in substance equity claims for CCAA purposes. The objectors also challenged the validity of USS’s secured claims.


The Court held that the objecting parties had the burden of proof in respect of both the debt re-characterization and secured claim issues.


After canvassing and distinguishing Canadian and American case law on the question of how to characterize debt instruments, Justice H. Wilton-Siegel applied a two-part test for determining how the advances made by USS to USSC should be characterized, which asks:

  1. Did the lender subjectively expect to be repaid principal and interest out of the cash flows of the borrower over the term of the loans at the time the loan advances were made?
  2. Was the lender’s expectation objectively reasonable?

For the first branch of the test, the Court noted that it would disregard the form of the loan documentation as being, in effect, “a sham” if: at the time of the advance of funds the lender had no expectation that the borrower would honour any payment obligation when due in the absence of available cash; and the lender intended from the outset to waive all interest as it becomes payable and forgive the principal.

With respect to the second branch of the test, this question engages, among other issues, the adequacy of the capitalization and debt capacity of the subsidiary. The Court stated that any determination of the reasonableness of a lender’s expectations at the time a loan is entered into is prospective in nature and therefore highly speculative, and necessarily involves consideration of the borrower’s financial capacity under a variety of possible future economic scenarios. As such, the Court cautioned against reaching a conclusion of there being no reasonable expectation of repayment in the absence of a detailed consideration of such scenarios and compelling evidence that there was no basis for the lender’s expectations.

The Court also identified the following principles in connection with the re-characterization analysis:

  1. A parent corporation may divide its investment in an acquired corporation between debt and equity as it chooses or, put another way, can lend money to a wholly-owned subsidiary without that loan being treated automatically as part of its equity investment in the subsidiary
  2. Characterization of debt claims must be analyzed as of the date of the advances, and behaviour subsequent to any advance cannot, on its own, justify a re-characterization of such advance
  3. Characterization must not be viewed in isolation from the economic circumstances in which the advances were made


The objecting parties pointed to various factors to support their assertion that the loan advances at issue should be treated as an equity claim, including the absence of arm’s length negotiation regarding the terms and conditions of the loans, long maturity dates under the loan agreements, the history of interest payments and interest waivers, USS’s control over USSC, and the fact that USSC would not have been able to obtain similar financing from a third-party bank or institutional lender. USS asserted, among other things, that the debt instruments were loan agreements on their face, had prescribed terms for the payment of principal and interest, had no terms tying any payments to USSC’s financial performance, and were documented separately from equity contributions in both the lender’s and borrower’s books and records.

The Court concluded that on a balance of probabilities, at the time of the advances under the loan agreements USS expected USSC would repay interest and principal in accordance with the loan terms, and that USS’s expectations in that regard were reasonable. As such, the Court confirmed these claims as debt claims.


The Court (with the exception of one claim that remains to be determined) also confirmed USS’s secured claims. Their validity had been challenged for lack of consideration at the time the security agreements were executed and on the grounds that they were void because they constituted a fraudulent preference under section 95 of the BIA.

The Court concluded that consideration was not required in order for a grant of a security interest to be effective. In any event, the Court found that consideration had been provided in light of the acknowledgment of the parties in the relevant agreements as to the adequacy of the consideration given as well as the fact that additional funds were advanced under the loan agreement subsequent to the grant of security. On the preference issue, the Court held that the secured advances did not give USS a preference over other creditors because such advances were made in circumstances in which USS was not obligated to advance further funds and were used in the ongoing operations of USSC’s business.