Emerging entity’s solvency is condition precedent to the use of a CBCA plan of arrangement restructuring secured debt

A recent Alberta case¹ has addressed the proposed use of a plan of arrangement under the Canada Business Corporations Act (“CBCA”) where proceedings under insolvency statutes may be more appropriate.  In Connacher Oil, Connacher Oil and Gas Limited (“Connacher”) and 9171665 Canada Ltd. (“Arrangeco”, and together with Connacher, the “Applicants”) made an application to the Alberta Court of Queen’s Bench for a final order approving a plan of arrangement to restructure Connacher pursuant to section 192(4) of the CBCA.  At the request of the first lien creditor who opposed the application, Justice Jones denied the application, primarily because the solvency of the entity emerging from the arrangement could not be determined at that time.

Connacher’s debt obligations included (a) an aggregate of approximately USD $124 million in secured first lien credit (the “First Lien Notes”) owed to various creditors (the “First Lien Noteholders”); and (b) approximately USD $550 million and CDN $350 million in two different classes of second secured lien notes (the “Second Lien Notes”), which were owed to various noteholders (the “Second Lien Noteholders”). If the plan of arrangement sought by the Applicants (the “Plan of Arrangement”) was approved, Connacher and Arrangeco would amalgamate to form a new entity, all accrued and unpaid interest on the Second Lien Notes would be settled and the Second Lien Notes would be converted pro rata into common shares of Connacher. In addition, new second lien convertible notes would be issued in the principal amount of USD $35 million and Connacher would have the option to obtain a new $30 million first lien term facility. The Arrangement (as described in the Plan of Arrangement) would have the effect of reducing Connacher’s debt by approximately $1 billion and its annual interest costs on the Second Lien Notes by about $80 million.

A plan of arrangement under section 192 of the CBCA requires an interim order from the Court, a vote of the affected parties and then a final court order approving the plan. Despite objections from the administrative agent on behalf of the First Lien Noteholders (the “Administrative Agent”), the Applicants successfully obtained an interim order.  The Applicants’ shareholders and the Second Lien Noteholders each held meetings after the interim order, in which the Plan of Arrangement was approved by the requisite majorities of each group. Under the Plan of Arrangement, the First Lien Noteholders were not given a vote as it was alleged that their rights would not be affected by the Arrangement. The final order was sought following the shareholder and Second Lien Noteholder approval.

Prior to the final order, however, the Administrative Agent commenced an action in the New York Supreme Court (the governing law jurisdiction of the First Lien Notes agreement) against Connacher for the principal amounts owing under the First Lien Notes (the “New York Action”). In anticipation of the Arrangement, Connacher had not made an interest payment owing under the Second Lien Notes on February 2, 2015 because the parties had agreed to add that interest to the Second Lien Notes to be restructured. The Administrative Agent claimed Connacher’s failure to make the interest payment constituted a default under the First Lien Notes agreement due to a cross-default provision in the First Lien Notes agreement, entitling the First Lien Noteholders to accelerated payment. Connacher argued that the failure to make the interest payment was part of a permitted second lien note restructuring that was explicitly carved out of the events of default under the First Lien Notes agreement. At the time of the hearing for the final order, the New York Action had not yet been decided.²

In considering whether to issue the final order, Justice Jones determined the following to be the threshold issue: “Does the Court have the jurisdiction to issue a final order under the CBCA where the entity emerging from the arrangement will or might be insolvent?”³ Previous cases that considered solvency requirements had not had to confront a situation where the emerging entity itself might be insolvent following the Arrangement. In this case, if the New York Action was decided in favour of the Administrative Agent, the emerging entity would not be able to satisfy its accelerated obligations and still meet its ongoing obligations.  The Court needed to consider whether a determination of the non-insolvency of the emerging entity is a condition precedent to the exercise of its authority under section 192.

A related but distinct question for the Court to consider was: “Whether it is appropriate for the Court to exercise the broad power given to it under section 192(4) to waive an alleged event of default under security agreements, which might, were there indeed a default, impair the Court’s ability to determine that the emerging entity will, indeed, be solvent.”⁴ Connacher had argued that if the failure to make the interest payment to the Second Lien Noteholders was indeed an event of default under the First Lien Notes agreement, the Court had the power to waive the alleged default thereby ensuring the solvency of the emerging entity. The Administrative Agent, on the other hand, argued that effecting a deemed waiver of the event of default would compromise the rights of the First Lien Noteholders. In their view, the Plan of Arrangement as proposed would not, therefore, resolve the interests of all parties in a fair and balanced way.

In determining that solvency is an essential requirement for the exercise of the Court’s power to approve the Plan of Arrangement and that situations involving a potentially insolvent emerging entity were best dealt with under insolvency statutes, Justice Jones referred to the following passage from the 2011 Annual Review of Insolvency Law:

The CBCA arrangement provisions were not designed to deal with the full range of issues affecting multiple parties that many insolvencies can present… Where an applicant requires broader third party orders restraining otherwise lawful conduct, especially on a permanent basis, one must question whether the proceeding is more properly administered under true insolvency process as opposed to the CBCA. The broader the third part impact requested, the more searching the analysis of whether the CBCA truly should be applied.⁵

Justice Jones expressed concern about the impact that granting an order in favour of the Applicants might have on the attitude of lenders, particularly foreign lenders.  He also expressed hesitation to resort to use of section 192(4) of the CBCA, thereby “potentially affect[ing] the resolution of the rights of parties to significant contracts affecting an applicant which are the subject of a present action in another jurisdiction which Connacher appears to have attorned to.”⁶

Further, the Court concluded that the exercise of power in section 192(4) of the CBCA to issue a no-default order should be limited to circumstances involving corporations which do not require the order to assert their solvency. In its view, the Court ought not to exercise its authority under the CBCA to create conditions precedent to the application of that same statute. Without issuing a no-default order, thereby eliminating the basis for the New York Action altogether, the Court could not conclude that the emerging entity would be solvent until such time that the New York Action was itself determined. Accordingly, the Court was unable to find a valid business purpose underlying the Plan of Arrangement, and was unable to conclude that the objections of the First Lien Noteholders had been resolved in a fair and balanced manner.  The application for the final order was therefore denied.^{7 8}