In Canada, as in the US, corporate debtors are permitted with court approval to obtain DIP financing on a super-priority basis. The Order typically provides protections as hard as a nutshell, including that pension claims cannot crack the shell of protection and are subordinated to the new DIP loan. A recent Canadian decision, however, held that certain pension claims could crack the nut wide open and should be paid ahead of a DIP loan. Re Indalex Limited, 2011 ONCA 265 (Apr. 7, 2011).

The claims in question represented the entire amount of the underfunded obligations under two registered defined benefit pension plans arising as a result of their wind-up. While the facts of Indalex were somewhat unique and, therefore, the decision does not establish a hard-and-fast rule in relation to all future DIP lending, it does clearly provide food for thought as to the priority of DIP financings in relation to registered pension plan claims in a proceeding under the Companies’ Creditors Arrangement Act (“CCAA”) and where a potential breach of fiduciary duty is involved. This is particularly so because the lower court had made an order in the CCAA case that granted a super-priority charge to secure the DIP loan, using language commonly deployed in Canadian DIP approval orders that purported to make such charge prior to security interests and trusts (statutory or otherwise).

The Indalex case raises complicated issues involving the interpretation of statutorily created trusts under pension benefits legislation, including whether and to what extent such trusts apply to deficiency obligations arising in relation to the wind-up of a registered pension plan, as well as constitutional issues arising from the interplay of federal and provincial legislation. Due to the specific facts of this case, fiduciary issues and conflicts of interest also arose due to the role played by the debtor (and its representatives/shareholder) as administrator of the pension plans. This paved the way to the Court of Appeal imposing the equitable remedy of a constructive trust on the proceeds to ensure the claims of the pension claimants were given priority.

Concurrently with Indalex Canada’s filing under the Companies’ Creditors Arrangements Act (CCAA), Indalex US filed for Chapter 11. DIP financing was approved by both courts, including a provision that was intended to provide priority over all existing secured claims and encumbrances, statutory or otherwise, which language was broad enough to include the underfunded obligations owing with respect to Indalex Canada’s pension plans for its executives and salaried employees. Indalex US eventually refinanced the DIP financing and, as a result, stepped into the shoes of the DIP lenders with respect to their priming claims in the CCAA proceedings.

At the time of the insolvency filings, Indalex Canada (as the plan administrator) was in the process of winding up one of the pensions plans in question (with wind-up of the other plan subsequently having been initiated by the government official with authority over the administration of registered pension plans. According to the Ontario Court of Appeal, the problem is that Indalex Canada, as debtor, took steps (including the incurrence of the DIP financing and the abandonment of the pension plans in their underfunded states) that were inconsistent with Indalex Canada’s fiduciary duties as plan administrator. In a nutshell, the Court of Appeal concluded that, as a result of this breach of fiduciary duty it was inappropriate for the DIP financing to be repaid ahead of the pension claims out of asset sale proceeds. Court decisions, of course, are seldom written “in a nutshell,” so readers are encouraged to review the entire 57-page decision (which can be found here) if you are interested in all the detailed flavors of the nut itself.

The Indalex Court states clearly that the elevation of certain pension claims above priming DIP financings was based on the particular facts at hand and that in future cases courts could invoke federal paramountcy principles in fashioning orders that could give a DIP lender priority over these types of pension claims. At the same time, the Court referred to the need for a “case-by-case” analysis, suggesting the possibility that other cracks in the DIP nutshell could occur going forward, including where a fiduciary duty is found to be owed and “good conscience” requires the application of an equitable remedy.

Prior to this decision, it was unclear whether a Court would hold that the entire amount of the underfunded obligations of a registered plan being wound up would benefit from the protection of a statutory deemed trust created by pension plan legislation. As such obligations can be substantial it will take time to assess the impact of the Indalex case on future restructurings. It may become more typical following an asset sale in a CCAA case and prior to distributions being made for third party creditors to take steps to put the debtor into bankruptcy to reverse these statutory priorities and bring the related claims into the unsecured creditors’ pool. In Indalex, the Court was unwilling to allow Indalex to voluntarily assign itself into bankruptcy as a means to defeat the priority of the statutory pension claims, holding that it would be inappropriate for a debtor with a fiduciary duty to pension plan beneficiaries to seek to avoid those obligations for the benefit of a related party in this manner.

Indalex certainly provides food for thought when analyzing the implications of priorities in CCAA proceedings where underfunded defined benefit pension plans are involved. Nor is it alone in recognizing special protections for employees, as the CCAA itself expressly provides that Canadian debtors, unlike US debtors, cannot reject collective bargaining agreements without the union’s consent. And then there is former CCAA debtor Air Debtor, which has been directed to establish a “nut-free buffer zone” around passengers with nut allergies. This caused us to check with Brazil as to its position concerning nuts, but their only response was to observe that a “Brazil nut” is actually a seed and not a nut at all…