Over the last few years, debtor-in-possession (DIP) loans have become a fixture in Canadian insolvency proceedings. Initially, in Companies’ Creditors Arrangement Act (CCAA) proceedings, courts used inherent jurisdiction to authorize DIP facilities because the statute did not expressly permit them. (Pending legislative changes will put explicit DIP provisions in the CCAA and the Bankruptcy and Insolvency Act (BIA).)

The increased popularity of DIP financing has raised concerns for secured creditors, especially where DIP lenders seek priority over all existing creditors. Existing secured creditors inevitably want to enforce their security without the risk that their collateral will effectively be depleted by DIP facilities.

Although secured creditors sometimes despair at the ease with which DIP facilities are approved, a recent decision shows that courts can and do consider a broad range of factors and are prepared to make hard decisions that can effectively terminate an insolvency proceeding.

In 1252206 Alberta Ltd. v. Bank of Montreal, the debtor sought a $1.1 million DIP loan after filing a Notice of Intention to Make a Proposal under the BIA. The debtor wanted to complete 12 units of a 38 unit real estate development and sell the units over a six month period. The sale proceeds would then repay the DIP loan and the surplus would be applied towards a $2.9 million mortgage held by Bank of Montreal, the sole secured creditor. (The remainder of the mortgage was to be paid by a refinancing of vacant land in the development.) The principals of the debtor also agreed to inject a further $575,000 in equity.

The Bank opposed the DIP financing. It contended that it had lost faith in the management of the debtor and that it would vote against any proposal made by the debtor.

The court considered whether the benefit of the DIP would outweigh the prejudice to the Bank and whether it would bring greater value to the enterprise than if the assets were liquidated. The court was concerned that allowing the application for DIP financing would remove from the secured creditor (the Bank) control over the means for recovery of its loans (i.e., liquidation). Further, the Bank would bear the greatest risk if the DIP loan were advanced and the units completed, but it would have no say in the process. The court concluded that there was no guarantee that the project would be completed and the units sold. Accordingly, the court refused to approve the DIP facility. At the same time, the court also refused to give the debtor any more time to make a proposal. As a result, the debtor immediately fell into bankruptcy and the Bank was permitted to realize upon its security.

This case is important for two reasons. First, it shows that courts are prepared to consider DIP financing in BIA proposals as well as CCAA proceedings. In fact, the court proceeded on the basis that it had inherent jurisdiction to approve DIP loans in BIA matters. Second, the court did not accept at face value the debtor’s assertion that the DIP facility would allow the company’s value to be maximized. Instead, the court placed significant weight on the prejudice and loss of control that the Bank would suffer. In this case, no DIPping was allowed.