A recent decision of the Ontario Court of Appeal (Re Indalex Ltd., 2011 ONCA 265) has raised questions regarding the validity of the super priority status afforded to Debtor in Possession (“DIP”) financing in circumstances in which there is a statutory deemed trust arising out of a pension plan windup deficiency. Although the decision is very fact specific, it nonetheless came as a surprise to many Canadian insolvency practitioners, who understood that courts would apply a priority scheme under the Companies' Creditors Arrangement Act, R.S.C. 1985, c. C-36 (“CCAA”) that was consistent with the scheme under the Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3, in which many such statutory deemed trust claims are inoperative.
The Indalex group of companies were the second largest manufacturer of aluminum extrusions in the United States and Canada. It was the sponsor and administrator of two registered pension plans: one for salaried employees (the “Salaried Plan”) and one for executive employees (the “Executive Plan”).
On April 3, 2009, Indalex and other Canadian companies in its corporate family obtained protection from their creditors pursuant to the CCAA. As of the date of the commencement of those proceedings, the Salaried Plan and Executive Plan were both underfunded, and the Salaried Plan was in the process of being wound up.
Early in the proceedings, Indalex obtained a court order permitting it to obtain DIP financing. Pursuant to that order, the DIP lender obtained a charge over all of Indalex’s assets in priority to all other claims. The DIP loan was also guaranteed by Indalex’s parent corporation in the United States (the “Guarantor”).
There were ultimately insufficient assets to repay the unfunded liabilities in the Salaried Plan and Executive Plan. At a hearing to approve the sale of Indalex’s assets, the United Steel Workers Union (“USW”), appearing on behalf of beneficiaries under the Salaried Plan, and a group of retired executives appearing on behalf of beneficiaries of the Executive Plan, asked for and obtained an order from the court requiring the Monitor to retain $6.75 million of the sale proceeds (the “Proceeds”) pending resolution of a priority dispute. In particular, the USW and retired executives argued that the unfunded pension liabilities in both the Salaried Plan and Executive Plan should rank in priority to the court ordered charge securing the DIP loan, and as such the Proceeds should be used to fund those pension liabilities rather than repay the DIP loan. The basis for this argument was, among other things, s. 57 of Ontario’s Pension Benefits Act, R.S.O. 1990, c. P.8 (the “PBA”), which creates a statutory deemed trust for “an amount of money equal to employer contributions accrued to the date of the wind up but not yet due under the plan or regulations”.
In light of the Court’s decision to require the Monitor to withhold the Proceeds, the Guarantor paid the $10.75 US million shortfall on the DIP loan to the DIP lender, making the DIP lender whole. The primary secured creditor of the US parent company was then subrogated to the DIP lender’s rights to collect the Proceeds.
At first instance, the CCAA judge held that the deemed trust provisions of the PBA were not applicable, on the basis that the Executive Plan was not being wound up, and the payments to the Salaried Plan to address its deficiency were not yet “due” or “accruing due” under the PBA or its regulations. That decision was overturned on appeal.
With respect to the Salaried Plan, the Court of Appeal held that the deemed trust provided for in s. 57(4) of the PBA extended to the entire wind-up deficiency of the Salaried Plan. Further, as Salaried Plan beneficiaries were not given notice of the DIP lender’s application to subordinate their deemed trust claim when it obtained approval for the DIP loan, and because full disclosure of the pension priorities issue was not placed before the judge when the DIP loan was approved, the Court held that the PBA deemed trust priority was not subordinated to the super priority DIP charge. It should be noted, however, that the Court left open the possibility of the PBA deemed trust being subordinated to DIP charges on a “case by case basis”, citing as an example a circumstance in which “.. the application of the provincial legislation [ie. the PBA] would frustrate the company’s ability to restructure and avoid bankruptcy.”
With respect to the Executive Plan, the Court noted that as that plan was not being wound up as of the date of the asset sale, a deemed trust with respect to the Executive Plan appeared to be inconsistent with the PBA. However, rather than making a definitive finding on that issue, the Court agreed with the USW and Former Executives that Indalex acted in a conflict of interest during the CCAA proceeding. In particular, the Court held that during the course of the restructuring Indalex was duty bound as a debtor corporation to treat the interests of all stakeholders fairly when their interests conflicted, but ultimately was obliged to act in the best interests of Indalex. Meanwhile, as a plan administrator, Indalex was also duty bound to act in the best interests of the pension plans’ beneficiaries. Due to this conflict, the Court found that Indalex breached its fiduciary duties as plan administrator to the Executive Plan’s beneficiaries, and imposed a constructive trust over the balance of the Proceeds in favour of beneficiaries of that Executive Plan, in priority to the DIP charge.
An application for leave to appeal this decision to the Supreme Court of Canada is currently outstanding. Clarification of the matters at issue will surely be well received by members of the insolvency, lending and pension industries.