In a year quite unlike any other, the landscape of Canadian restructuring law saw significant developments in 2020. The COVID-19 crisis put novel issues before the courts, challenged businesses in unforeseen ways and saw various supports and concessions offered to struggling businesses from governments and creditors. Ultimately, while the supports and concessions enabled many businesses to avoid insolvency proceedings in 2020, many others sought the protection of an insolvency filing, with industries such as the retail industry particularly impacted.
Overall, while there was a decline in bankruptcies and proposal proceedings under the Bankruptcy and Insolvency Act (“BIA”), 2020 saw an increase in larger, more complex restructurings under the Companies’ Creditors Arrangement Act (the “CCAA”), with 60 CCAA filings nationwide in 2020, far surpassing the 38 CCAA filings in 2019.
Beyond the pandemic, the Supreme Court of Canada released two significant insolvency-related decisions and we also saw the first contested Reverse Vesting Order issued in Canada.
In this post, we summarize certain of these insolvency law highlights from 2020 and look ahead to 2021.
The Use of Litigation Funding Agreements as Interim Financing
In 9354-9186 Québec inc. v Callidus Capital Corp., 2020 SCC 10, the Supreme Court of Canada delivered a comprehensive decision considering litigation funding agreements in the context of the restructuring of the Bluberi Group, as well as the discretion of a CCAA judge to bar a creditor from voting on a plan. The SCC unanimously held that:
- a CCAA judge has discretion to bar a creditor from voting on a plan of arrangement if the creditor is acting for an improper purpose. Whether the judge ought to exercise such discretion is a fact-specific inquiry that must balance the objectives of the CCAA;
- the court may approve litigation funding agreements as interim financing pursuant to section 11.2 of the CCAA. Whether such funding ought to be approved as interim financing is also a fact-specific inquiry that should have regard to s. 11.2 of the CCAA and the remedial objectives of the CCAA; and
- a third party litigation funding agreement that extends financing to a debtor company seeking to realize on a litigation asset is not necessarily (or even generally) a plan of arrangement. A plan of arrangement requires some compromise of creditors’ rights. Analogizing to a “pot of gold”, the SCC noted at paragraph 111 that “… Bluberi’s litigation claim is akin to a “pot of gold” …. Plans of arrangement determine how to distribute that pot. They do not generally determine what a debtor company should do to fill it. The fact that the creditors may walk away with more or less money at the end of the day does not change the nature or existence of their rights to access the pot once it is filled, nor can it be said to “compromise” those rights.”
The SCC also reviewed the evolution of liquidating CCAA’s, noting that the predominant remedial objective under the CCAA can change. In particular, where a reorganization is not possible, the objective of the CCAA proceeding focuses on preserving going concern value and ongoing business operations; however, where a sale is completed and the proceedings are dealing with residual assets, the focus is on maximizing creditor recovery. Finally, the Supreme Court emphasized in its decision the high degree of deference that is owed to discretionary decisions made by judges supervising CCAA proceedings.
Recognition of the Anti-Deprivation Rule in Bankruptcy and Insolvency Proceedings
In Chandos Construction Ltd. v Deloitte Restructuring Inc., 2020 SCC 25, the Supreme Court of Canada confirmed that the anti-deprivation rule continues to exist in Canada. The SCC also confirmed that there is an effects-based test for when the anti-deprivation rule applies, declining to follow a United Kingdom Supreme Court decision that applied a purpose-based test.
The anti-deprivation rule voids contractual provisions that prevent property of a bankrupt from forming part of the bankrupt’s estate to be distributed in accordance with the BIA scheme. The clause in question in this case reduced payments due under a contract by 10% upon an insolvency and stated this reduction was “a fee for the inconvenience of completing the work using alternate means and/or for monitoring the work during the warranty period.”
A majority of the Supreme Court held that the anti-deprivation rule continues to exist in Canada and has not been eliminated by case law or statutory amendments. The SCC also rejected a purpose-based approach that would consider whether there was a bona fide commercial purpose for the contractual provision. Instead, the SCC established a two fold test in respect of the application of the anti-deprivation rule:
- the contractual clause must be triggered by an event of insolvency or bankruptcy; and
- the effect of the clause must remove value from the estate (regardless of whether there was any other purported purpose for the clause).
In confirming this ‘effects-based’ test, the SCC also noted that there are “nuances” to the rule, including that there may be contractual provisions that eliminate assets but not value from the bankrupt estate, which may not offend the rule, and that the rule is not offended by provisions taking security, acquiring insurance, or requiring third-party guarantees.
The practical effect of the decision, in the context of insolvency proceedings, is that certain contractual clauses triggered by a contracting party’s insolvency that remove value from the debtor’s estate are void and will not be given effect by Canadian courts. This case also has implications for those drafting contractual provisions who will want to consider the ‘nuances’ highlighted by the Court and be mindful of the two-fold test, with keen drafters likely to consider whether there are alternatives to an insolvency trigger.
Lenders Beware: The Deemed Trust for Unremitted GST/HST
In Toronto-Dominion Bank v The Queen, 2020 FCA 80, the strength of the deemed trust and potential impact on secured creditors was further established. In this case, an individual debtor (Weisflock) owned a sole proprietorship and collected but did not remit GST to the Receiver General as part of its operations. The lender, unaware of the unpaid remittances in respect of Weisflock’s business, advanced funds to him in respect of a mortgage on his home. The lender was subsequently repaid upon the sale of the house. Only after the lender had been repaid did CRA assert a GST claim.
The CRA alleged that the proceeds from the sale of the home were subject to a deemed trust pursuant to the Income Tax Act at the time the lender was paid out, requiring the lender to disgorge the funds to the CRA. The Federal Court of Appeal found in favour of the CRA, affirming that a deemed trust ranking in priority to all security interests arose over unremitted GST payments at the time the GST was collected but not remitted, and that there was no requirement for a crystallizing event such as a bankruptcy. The Bank has sought leave to appeal to the Supreme Court of Canada and is awaiting a decision on whether leave will be granted.
Quebec Superior Court Grants First Reverse Vesting Order under CCAA after Contested Hearing
In Arrangement relatif à Nemaska Lithium inc., 2020 QCCS 3218, the Quebec Superior Court granted the first Reverse Vesting Order (“RVO”) under the CCAA after a contested hearing.
Unlike a traditional Approval and Vesting Order, which transfers desirable assets from the debtor company to the purchaser in exchange for sale proceeds, an RVO allows the debtor company to retain desirable assets while transferring unwanted assets and liabilities to a newly-incorporated residual corporation, along with sale proceeds to be distributed to creditors. This allows the debtor company to continue in the hands of a new investor (through share purchase agreements rather than asset sale agreements), thus preserving existing rights such as permits, operating agreements, licenses and tax attributes.
The supervising judge rejected the argument that approving the RVO was outside the powers of the Court under the CCAA and the argument that the RVO was an impermissible compromise of creditors outside of a plan of arrangement (and without a creditor vote). The CCAA judge found support for the legal basis of the RVO under section 36 of the CCAA, among other things. In doing so, the supervising judge emphasized both the remedial purpose of the CCAA and the discretion afforded to a CCAA judge in managing the case. A request for leave to appeal was dismissed by the Quebec Court of Appeal (2020 QCCA 1448) and, while the creditor sought leave to appeal to the Supreme Court of Canada, the transaction has now closed.
COVID-19 and Post-Filing Rent
The pandemic has left a notable imprint on post-filing rent in particular. In a number of cases debtor companies sought to be relieved of the obligation to pay post-filing rent based on the argument that they were not able to “use” the premises as a result of COVID-19 restrictions and health orders. In Quest University Canada (Re), 2020 BCSC 921, the court acknowledged that the CCAA contains no requirement for the debtor company to make payments for post-filing supply, including rent; however, the court also noted that section 11.01 of the CCAA seeks to balance the interests of debtors and post-filing suppliers by providing that no order made under sections 11 or 11.02 of the CCAA prevents any person from requiring immediate payment for goods, services and “use of leased…property” after the CCAA order is made.
In Quest, the debtor had vacated certain residences (previously occupied by students and staff) because of safety concerns and public health orders relating to COVID-19. However, the court held that Quest was “using” the residences for purposes of section 11.01 of the CCAA for a variety of reasons, including that it was asserting sole possession of the residences and had not disclaimed the lease. The court refused to equate lack of physical occupation of the residences in question with lack of use. In its decision, the court referred to the CCAA initial order issued by the Ontario court in Comark in which post-filing rent was deferred until the debtor was legally entitled to open its stores to the public for its ordinary course business operations; however, the B.C. court noted that the Comark initial order was made on a motion without notice to the landlords and that the initial order was later amended to require payment of post-filing rent.
In the restructuring of retailer Groupe Dynamite in Quebec, the court issued a decision in early 2021 that bears mention here. In it, the court acknowledged that Dynamite’s ability to use certain leased premises to operate its stores was “severely limited by the Covid Restrictions”. However, it also concluded this still constituted “use” for purposes of section 11 of the CCAA. The court found that “where leased premises are occupied by a debtor and cannot be leased to anyone else, the landlord is not prevented from demanding immediate payment of rent regardless of whether or not the debtor is carrying on business.” In other words, the debtor is not relieved of the obligation to pay post-filing rent when it is asserting a right to sole possession of the premises and has not disclaimed the lease.
Looking Ahead to 2021
2021 is poised to continue the brisk pace of change seen in 2020. COVID-19 will continue to play a role in the economy, although the precise impacts are uncertain. At this stage, there is no clarity if and when ‘business as usual’ may return, whether the creditor support and concessions seen in 2020 will continue in 2021 and, if so, whether they will be sufficient to continue to stave off insolvency proceedings for many challenged Canadian businesses.
It is also unclear what government measures will be introduced to combat COVID-19’s economic impact, although various additional measures are expected. At the federal level, the Fall Economic Statement delivered on November 30, 2020, notes that Canada’s economic recovery will be more challenging if business bankruptcies increase and describes that the Federal Government intends to address this by designing an investment plan during early 2021, as well as by exploring options to enhance the Large Employer Emergency Financing Facility (“LEEFF”). The LEEFF program was introduced in May 2020 with a primary objective of avoiding bankruptcies of otherwise viable firms. What the enhancements to the LEEFF program will include remain to be determined as does the possibility of other measures from government to bridge struggling businesses over to a post-COVID recovery period – whenever that may be.
There are also notable court decisions on the horizon in 2021. For instance, the Supreme Court of Canada is expected to render judgment in the appeal of Canada v. Canada North Group, 2019 ABCA 314, which deals with the priority ranking of charges granted under the CCAA. This decision will be the culmination of a case that McCarthy Tétrault identified as one of the key cases in 2017.
Ultimately, as 2021 commences there is significant uncertainty for Canadian businesses, a possibility that restructuring proceedings may be engaged further in 2021 and a likelihood that expertise with distressed businesses and restructurings will be in demand as the year progresses. Regardless of what 2021 may ultimately bring, we will continue to share relevant insights as the crisis continues into 2021.