It is well-established that Canadian courts have jurisdiction to approve a plan of compromise or arrangement under the Companies’ Creditors Arrangement Act that includes releases in favour of third-parties. The leading decision on the issue remains Metcalfe & Mansfield Alternative Investments II Corp., which arose in response to the liquidity crisis that threatened the Canadian market in asset-backed commercial paper after the U.S. sub-prime mortgage collapse in 2007. The general rule, as established by the Ontario Court of Appeal, is that third-party releases must be reasonably connected to the restructuring in order for a plan that contains them to be sanctioned.
It is relatively common for certain parties, such as the Monitor, its counsel and other persons retained as advisors for the restructuring, to obtain the benefit of a release in a plan of compromise and arrangement. Releases of this nature are generally uncontentious both because legitimate claims against these parties are rare and because these persons are engaged almost exclusively to work on, and therefore make an obvious material contribution to, the reorganization. The wide jurisdiction afforded to supervising courts in a CCAA proceeding also allows for releases in favour of other third-parties including, for example, a debtor corporation’s auditors or its non-filing parent company. Releases for these parties will be more controversial in the eyes of creditors or shareholders searching for solvent defendants for subsequent litigation. When seeking a third-party release applicants are well-advised to consider the following issues, as recently articulated by the Honourable Regional Senior Justice Morawetz in sanctioning a plan of compromise and arrangement involving Target Canada Co.:
- whether the parties to be released are necessary and essential to the restructuring;
- whether the claims to be released are rationally connected to the purpose of the plan;
- whether the plan can succeed without the releases;
- whether the parties being released were contributing to the plan;
- whether the releases benefit the debtors as well as the creditors generally;
- whether the creditors voting on the plan have knowledge of the nature and the effect of the releases; and
- whether the releases are fair, reasonable and not overly-broad.
In Target Canada, Regional Senior Justice Morawetz applied the test from Metcalfe and held that each of the third-parties taking the benefit of a release were properly entitled to it because each of them had contributed in tangible and material ways to the winding down of the debtor company’s business. The release of Target Canada’s US parent company was additionally justified because, in its role as plan sponsor, it has agreed to subordinate some intercompany claims and made cash contributions for the benefit of employees and landlords.
Directors of a debtor corporation, who face numerous challenges when their service is in respect of an insolvent or near-insolvent entity (as previously discussed here), may also take the benefit of a release in a CCAA plan of compromise or arrangement. In this regard it is important to note that section 5.1(2) of the CCAA imposes additional restrictions on a director release in that the release cannot extend to contractual rights of creditors or allegations of oppressive, wrongful or oppressive conduct. Metcalfe will be highly relevant in assessing the appropriateness of a director release but the scope of such release must ultimately be consistent with section 5.1(2) of the CCAA for the plan to be sanctioned.