On March 29, 2007 the Federal Government introduced Bill C-52: An Act to implement certain provisions of the budget tabled in Parliament on March 19, 2007 (Bill C-52). Bill C-52 amends the Bankruptcy and Insolvency Act (the BIA), the Companies’ Creditors Arrangement Act (the CCAA), the Winding-Up and Restructuring Act, the Canada Deposit Insurance Corporation Act (the CDICA) and the Payment Clearing and Settlement Act with respect to eligible financial contracts (EFCs).
The introduction of these EFC amendments was unexpected; it is unusual for insolvency law amendments to be dealt with in a federal budget. However, by introducing the EFC amendments in this manner, the amendments will all be implemented at the same time. This is an improvement to the piecemeal amendment approach that has been utilized in the past.
Bill C-52 is currently being debated at Third Reading. Once passed by the House of Commons, it will be forwarded to the Senate for approval. This Osler Update highlights the EFC amendments to insolvency legislation that are of particular interest to financial institutions and insolvency professionals.
EFCs and Insolvency
EFCs were first granted protection in 1992 when amendments were made to the BIA and the CDICA. Similar protection for EFCs was later introduced in the other statutes mentioned above. Derivatives are protected in insolvency situations if they are characterized as EFCs; the insolvency laws provide that a stay of proceedings is not applicable to EFCs and a solvent counterparty can rely upon insolvency events of default to terminate an EFC, accelerate any payments under an EFC and net the positions under an EFC or master agreements in accordance with the contractual provisions.
In November 2005, the Federal Government passed An Act to establish the Wage Earner Protection Program Act, to amend the Bankruptcy and Insolvency Act and the Companies’ Creditors Arrangement Act and to make consequential amendments to other Acts, S.C. 2005, c. 47 (Chapter 47, formerly Bill C-55) which introduced substantial amendments to the BIA and the CCAA. The provisions of Chapter 47 did little to improve the position of EFCs in an insolvency proceeding. To the contrary, Chapter 47 introduced super priority rules for unpaid wages, current pension deficiencies, debtor-in-possession (DIP) financing, and critical supplier and administrative charges, all of which could prime collateral security for derivatives in insolvency proceedings. Fortunately, Chapter 47 has not yet been proclaimed into force.
Bill C-52 introduces substantial amendments to Chapter 47 and other insolvency laws which strengthen the protection afforded to EFCs in insolvency proceedings.
Definition of EFCs
In the past 15 years, the approach to EFCs under insolvency legislation has been to specify, in the statutes, the types of derivatives which qualify as EFCs. If a derivative is not listed as an EFC under the applicable statute, the courts are required to determine whether the derivative is analogous to the specified list of potential derivatives. Bill C-52 eliminates this approach and provides that EFCs will be defined by regulation. This amendment may provide greater flexibility, since regulations can more readily be amended to adapt to new derivative products that emerge in the market (i.e. credit derivatives, which are not listed as EFCs under insolvency legislation).
Under existing insolvency legislation, a solvent counterparty can terminate an EFC with an insolvent counterparty and net the positions of the counterparties. However, if the solvent counterparty has a security interest in the insolvent counterparty’s property to secure payment or performance of the obligations under an EFC, enforcement of the rights and remedies under the security are stayed.
Bill C-52 will allow the realization of financial collateral securing obligations under EFCs. Financial collateral includes: cash or cash equivalents, securities, a securities account, a securities entitlement or a right to acquire securities. Bill C-52 grants protection to financial collateral to: (i) permit parties to deal with or realize upon financial collateral notwithstanding a stay of proceedings; and (ii) provide that no court order may be made which would have the effect of preventing a secured creditor from realizing or otherwise dealing with financial collateral. Thus, secured creditors will not be stayed from realizing on financial collateral in certain insolvency proceedings.
Additionally, insolvency legislation will be amended to provide that no order may be made in certain insolvency proceedings if the order would have the effect of priming financial collateral. This is an important amendment since, as noted above, Chapter 47 includes provisions which will permit courts to grant orders in respect of DIP financing, critical supplier and administrative charges that could prime financial collateral in connection with EFCs. As a result of Bill C-52, any DIP financing, critical supplier or administrative charge order made in an insolvency proceeding will not be able to prime financial collateral securing derivatives. However, Bill C-52 fails to provide any protection to financial collateral with respect to the statutory priorities introduced under Chapter 47 in respect of unpaid wages and current pension deficiencies. This will operate to prime financial collateral in connection with an EFC if and when Chapter 47 is proclaimed into force.
Bill C-52 also amends the fraudulent preference provisions of the BIA by providing that the presumption of intent to prefer a creditor following a transfer, charge or payment made to a creditor does not apply in respect of a transfer, charge or payment made in connection with financial collateral and in accordance with the provisions of an EFC.
Solvent counterparties who intend to enforce upon financial collateral may have to satisfy the notice requirements under the BIA, which oblige secured creditors to provide 10-days notice to an insolvent debtor prior to enforcing upon collateral which constitutes substantially all of the property of the debtor. The notice requirement cannot be waived by the debtor in advance of receiving the notice. It will be particularly relevant if the insolvent counterparty is a special purpose vehicle and its major or sole asset is the financial collateral.
EFCs Not Protected - Receiverships
The current receivership provisions of the BIA and court receivership orders under provincial laws do not provide specific protection for derivatives, nor do they provide for an automatic stay of the termination of contracts. This lack of protection for EFCs became evident in the receivership of the Norshield Group where the court stayed the exercise of all rights and remedies under futures, options, swaps and other financial contracts in respect of present or future rights or obligations. Additionally, the court granted a priority court charge to the receiver for all of its fees and disbursements, and allowed the receiver to incur borrowings to finance the receivership secured by way of a priority charge; these court charges ranked ahead of any security and cash deposits held by counterparties to secure obligations under various derivatives.
Chapter 47 makes substantial amendments to the receivership provisions of the BIA which will permit the courts to appoint a receiver with the power to act nationally. The amendments to the BIA contained in Bill C-52 which prohibit a court order from staying the termination of EFCs or priority of financial collateral are only applicable to a bankruptcy or a proposal. Thus, EFCs may continue to be at risk in a receivership.
The amendments to insolvency legislation contained in Bill C-52 introduce extensive protection for EFCs. They provide an exemption from a stay of proceedings in non-receivership insolvency proceedings to allow enforcement of financial collateral, and prevent the priming of DIP financing, critical supplier and administrative charges over financial collateral. However, EFCs remain potentially unprotected in receivership proceedings, and if and when Chapter 47 is proclaimed into force, EFCs will be primed by statutory priorities for unpaid wages and current pension costs.