Section 11.01 of the Companies’ Creditors Arrangement Act (the “CCAA”) states that no order under Section 11 or 11.02 of the CCAA has the effect of: (a) prohibiting a person from requiring immediate payment for goods, services, the use of leased or licensed property or other valuable consideration provided after the order is made; or (b) requiring the further advance of money or credit. On its face, this Section appears to give all equipment lessors the right to receive immediate payment for the use of the equipment leased by them to a debtor during a CCAA sanctioned stay of proceedings.

However, Section 11.01’s application was narrowed in the 1998 decision of the British Columbia Supreme Court in Re Smith Brothers Contracting Ltd. Still viewed as the leading interpretation of Section 11.01 (or Section 11.3 as it was at the time), Smith Brothers narrowed the type of lease that would fall under the Section to only those that have come to be defined as “true leases” (leases involving payment for the use of the underlying equipment only). By limiting Section 11.01’s application to “true leases,” the ruling essentially prohibited any leases that have come to be known as “financing leases” (leases that involve payment for the use of the underlying equipment and generate equity in the underlying equipment) from falling within the scope of Section 11.01. As a result, a lessor cannot require regular payments for equipment subject to a financing lease during the term of the lease while the debtor is subject to a CCAA stay of proceedings.

The Smith Brothers decision was recently referred to in the CCAA proceedings of Cow Harbour Construction Ltd. (“Cow Harbour”). In that case, De Lage Laden Financial Services Canada Inc. (“DLL”) sought a declaration that its lease agreement was a true lease and that it was entitled to approximately $900,000 in payments that had accrued since the commencement of the CCAA proceedings. The Alberta Court of Queen’s Bench found that the lease in question constituted a financing lease, denied DLL the lease payments and granted a receivership application brought by Royal Bank of Canada and a vesting order in respect of the equipment leased from DLL.

The Cow Harbour CCAA proceedings demonstrate the continued significance of the Smith Brothers decision on equipment lessors and the importance attached to the interpretation of the substance of lease agreements by courts. At a practical level, most financing leases are excluded from the scope of the meaning of Section 11.01 of the CCAA, and, accordingly, lessors should be aware that they will typically not receive any payment for use of their equipment by an insolvent company during a CCAA stay of proceedings.

The principles set forth in Smith Brothers and followed in other cases have received considerable criticism from legal practitioners and equipment lessors. While a narrower definition of lease agreements under Section 11.01 of the CCAA benefits the insolvent company and its creditors, the equipment lessor often receives no economic benefit from a restructuring proceeding. Furthermore, the continued use of the leased equipment often depreciates the value of equipment, thereby reducing a lessor’s recovery. Such treatment prompts many to ask whether equipment lessors are treated fairly in restructuring proceedings, given the fact that while their equipment continues to depreciate over time, it is still used to create or maintain value for the benefit of other stakeholders. We are not aware of any pending case that would have the effect of changing the law as developed by Smith Brothers.