The Ontario Court of Appeal recently addressed the issue of pension deficits in the context of a restructuring under the Companies' Creditors Arrangement Act (the "CCAA"). However, unlike past decisions, in Re Indalex the Court held that such deficits may have priority against monies advanced under interim debtor-in-possession ("DIP") financing agreements authorized by a CCAA judge. This apparent departure from the conventional understanding of the priority of pension deficit claims and related issues should raise concerns for lenders, employers, and plan administrators.
Indalex Limited ("Indalex") was the sponsor and administrator of two defined benefit pension plans, the Salaried Plan and Executive Plan. Indalex wound up the Salaried Plan effective December 31, 2006. The Executive Plan was wound up by order of Ontario's pension regulator effective September 30, 2009. The wind up valuation of each plan disclosed deficits totalling $6.75 million. Between the wind up dates of the two pension plans, in April 2009, Indalex sought and obtained protection from its creditors under the CCAA.
In the CCAA proceedings, Indalex was authorized to borrow funds under a DIP financing agreement. The CCAA judge ordered that the DIP financing was to be secured by a charge over the assets of Indalex which was to rank "in priority to all other security interests, trusts … and encumbrances, statutory or otherwise". The obligation to repay the DIP financing was guaranteed by the company's US parent ("Indalex US"). Indalex US was at that time subject to Chapter 11 proceedings under the United States Bankruptcy Code.
In July 2009, prior to the wind up of the Executive Plan, Indalex sold its assets through the CCAA proceedings to a third party; the pension plans remained with Indalex. Indalex sought court approval of the sale and of a distribution of the proceeds to the DIP lender. A group of former executives who participated in the Executive Plan and the union that represented certain members of the Salaried Plan objected to the distribution of the sale proceeds arguing that (a) the proceeds were subject to a deemed trust in their favour pursuant to the Pension Benefits Act (Ontario) (the "PBA"); and, (b) Indalex had breached its fiduciary obligations to the pension plans' beneficiaries as administrator of the plans. The sale was approved, as was a partial distribution of the proceeds. However, the CCAA Monitor retained $6.75 million of the sale proceeds (the "Reserve").
In August 2009, the union and the executives each brought expedited motions to determine their respective claims against the Reserve. Concurrently, Indalex brought a motion for leave to file a voluntary assignment in bankruptcy. The effect of this filing would have been to eliminate the provincial statutory deemed trusts – including the deemed trust under the PBA – and render any pension claim related thereto unsecured and subordinate to the rights of the DIP lender. The motion by Indalex was not dealt with by the CCAA judge. The motions by the former executives and the union were dismissed. However, they appealed to Court of Appeal which granted the requested relief for different reasons in the case of each pension plan.
On wind up of a pension plan, the employer is obligated to pay all amounts that "are due or that have accrued and that have not been paid into the pension fund" and, over a period of five years, the extent to which the liabilities exceed the value of the assets.
Deemed Trust: Salaried Plan
The Salaried Plan was wound up prior to the CCAA proceedings and the sale of the Indalex assets. The Court of Appeal held that the entire wind up deficit was subject to a deemed trust under the PBA. On the wind up of a defined benefit pension plan, subsection 57(4) of the PBA provides that the employer is deemed to hold in trust for the plan beneficiaries an amount equal to the employer contributions "accrued to the date of the wind up but not yet due". In this regard, the Court reasoned that all plan liabilities were accrued as of the wind up date. The deemed trust applies both to contributions that are due and have not been paid as well as the wind up deficit that is disclosed in the wind up valuation.
Breach of Fiduciary Duty and Constructive Trust: Executive Plan
The Executive Plan was not wound up until after the sale of the Indalex assets. The Court of Appeal held that there was no deemed trust with respect to the deficiency in the Executive Plan as it had not been wound up at the relevant time, i.e, the date on which the assets were sold and proceeds received.
The Court stated that it was "troubled" by the notion that Indalex could avoid the consequences of the deemed trust by its failure to wind up the Executive Plan. Accordingly the Court proceeded to impose a constructive trust equal to the amount of the Executive Plan deficit. The Court held that this remedy flowed from the company's breach of its fiduciary duty as administrator of the Executive Plan.
Indalex, as administrator of the Executive Plan, was subject to a fiduciary duty under the PBA to act in the best interests of the plan beneficiaries. The Court of Appeal found that Indalex breached that duty. Although Indalex sought CCAA protection in its capacity as employer, the Court held that this did not mean that Indalex could ignore its obligations as plan administrator. The Court of Appeal found that Indalex breached its fiduciary duty as administrator through the CCAA proceedings by, among other things, failing to act to take steps to address the known pension deficits and failing to give notice of the CCAA proceedings to the beneficiaries of the pension plans. In addition, the Court noted that as a fiduciary, Indalex had a duty to resolve the conflict by acting as a fiduciary. The Court found that Indalex took no such steps and, in fact, simply ignored its role as administrator.
Priority of the Pension Deficits
Having decided that the deemed trust applied in the context of the Salaried Plan and that a constructive trust applied in the context of the Executive Plan, the Court of Appeal proceeded to hold that both trusts took priority over the court-ordered super-priority charge for DIP financing.
The Court held that, on the facts of the Indalex case, the court-ordered charge in question was not sufficient to trump the PBA deemed trust for the Salaried Plan deficit. This was because, according to the Court of Appeal, the issue of the PBA deemed trust was not identified by the CCAA judge at the time that the charge was ordered; the doctrine of paramountcy was not invoked to render PBA subservient to the CCAA; and, there was no evidence that the deemed trust priority would frustrate the CCAA process. The Court held that, without a remedy, the funds that would flow to Indalex US (which itself was subrogated to the DIP lender) were directly connected to Indalex's breach of fiduciary duty. The Court found these facts to be material as concerns the Executive Plan and ordered that the Executive Plan deficit was to rank ahead of the DIP financing as well.
The Court of Appeal's decision has extended the traditional understanding of pension wind-up deficits and has created uncertainty.
For employers acting as administrators of employee pension plans, it is not entirely clear how duties to the corporation and to the plan beneficiaries may be demarcated; nor is it clear how a related conflict of interest may be addressed or resolved. When, if ever, should the employer resign as plan administrator; or, under the coming amendments to the PBA, be removed? Would the administrator even have the ability to resign?
For lenders, the potential imposition of super-priority trusts in favour of pension deficiencies is a significant concern. It is not entirely clear when such trusts may arise, particularly in the case of the constructive trust imposed by the Court of Appeal in Indalex. When can DIP lenders safely rely on court-ordered DIP charges?
For employers contemplating a CCAA filing, the issue of pension deficits must be addressed at the outset. As the Court of Appeal said, a CCAA judge has the authority in the appropriate case to create priority charges for DIP financing that rank ahead of pension deficit claims. What facts support such a charge and what is the test that an applicant must meet?
Given the state of uncertainty created by the Court of Appeal decision, we hope that clarification will be sought from the Supreme Court of Canada.