In Re Sino-Forest Corporation1 , the Ontario Court of Appeal upheld the interpretation of “equity claims” employed by Justice Morawetz of the Ontario Superior Court of Justice (Commercial List).

Morawetz J. was asked to determine whether claims made against Sino-Forest Corporation (“SFC”) by its shareholders pursuant to class action proceedings (“Shareholder Claims”) and related indemnification claims made against SFC by its auditors and underwriters (“Related Claims”) were “equity claims” for the purpose of the Companies’ Creditors Arrangement Act (“CCAA”).

The shareholders claimed they had purchased their shares at an inflated price and if the true value of the corporation had been reflected in the offering materials, they would have paid much less. They commenced class action proceedings naming SFC as a defendant as well as SFC’s directors, officers, auditors, and underwriters. In turn, the auditors and underwriters counterclaimed against SFC and its subsidiaries, relying on contractual and common law claims for indemnification and contribution.

Ontario Superior Court of Justice

Morawetz J. found that the characterization of the Related Claims was intrinsically linked to the nature of the Shareholder Claims. He found that the Shareholder Claims were “clearly equity claims” pursuant to section 2(1)(d) of the CCAA.2  He further found that if Shareholder Claims were claims for a monetary loss resulting from the ownership, purchase, or sale of an equity interest under section 2(1)(d), then the Related Claims fell squarely within the parameters of section 2(1)(e), which deals with contribution or indemnity in respect of claims of monetary loss. The court found that the claims for indemnification and contribution were an alternative means by which recovery of an equity investment could be achieved and that to enable an indemnified party to be treated as creditors would provide an indirect remedy where a direct remedy is not available.3

On August 16, 2012, SFC’s auditors and underwriters each served notices of motion for leave to appeal the decision of Morawetz J. to the Ontario Court of Appeal.

Ontario Court of Appeal

At issue on appeal was the interpretation of “equity claim” under section 2(1)(d) of the CCAA. In particular, the auditors and underwriters argued that Justice Morawetz erred in: (1) concluding that the claims at issue were equity claims; and (2) determining this issue before the claims procedure established in SFC’s CCAA proceeding had been completed.4 Justice Goudge, Hoy and Pepall, collectively writing for the Court, upheld Justice Morawetz’s decision.

The Court held that Morawetz J. was correct in interpreting “equity claim” with reference to the nature of the claim, and not the identity of the claimant. Further, the Court held that the definition of “equity claim”, as amended in 2009, incorporates expansive language supporting a broad and contextual interpretation.5 The Court held that Parliament could have expressly restricted the definition of “equity claim” by stating clearly that to constitute an equity claim, the contributions or indemnities must be made by shareholders.  Further, the Court stated that the internal logic and scheme of the definition supported characterizing the Related Claims as equity claims.6

The Court re-cast the statement by Morawetz J. that if the Related Claims were not characterized as equity claims, the CCAA would permit an indirect remedy when a direct remedy is not available. The Court of Appeal stated that the enactment of section 6(8) of the CCAA, which forbids a court from sanctioning a plan unless it provides for the payment of non-equity claims prior to the payment of equity claims, illustrates Parliament’s intention to ensure that a monetary loss suffered by a shareholder not diminish the assets of the debtor available to the general benefit of creditors. It would be contrary to Parliament’s intention to diminish the assets available to general creditors by failing to treat contribution or indemnity claims by underwriters and auditors as equity claims, where the contribution or indemnity is sought in connection with a shareholders suit against the underwriters and auditors for monetary loss.  

With respect to the argument that Morawetz J. decided this issue prematurely, the Court held that Morawetz J. was correct in characterizing the claims at this stage in the proceedings. SFC and the Monitor had taken the position that the proceedings be completed as soon as possible, and there was no clear prejudice in determining the issue at this stage. Accordingly, there was no basis to interfere with Morawetz J.’s decision.7