Originally part of a 49 jurisdiction Global Practice Guide by Chambers and Partners, this section on Insolvency in Canada has been republished with permission.
Out now, the Chambers and Partners Insolvency 2021 Global Practice Guide is a resource for legal and non-legal professionals to learn about the differing legal regimes that apply to business restructurings, reorganisations, rehabilitations, insolvencies and liquidations in 49 jurisdictions.
The section on "Trends and Developments" for the Canadian jurisdiction, which focuses on one of the most topical trends in Canadian restructurings – "reverse vesting orders" (RVOs), was authored by David Cohen and Virginie Gauthier.
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NOTE: The information and summaries in the Guide are not provided as legal advice and should not be relied upon as such. Readers should consult the contributing authors or other qualified legal and non-legal advisers directly if they need to further understand what rules and practices might apply in particular situations and jurisdictions.
Trends and developments in Canada
Restructuring legislation in Canada enables financially distressed companies to avoid bankruptcy, foreclosure or the seizure of assets while maximising returns for their creditors and preserving both jobs and a company's value as a functioning business. Restructuring professionals generally accept that the ability of insolvent companies to restructure their businesses in a cost-efficient manner ultimately benefits all stakeholders. This article will review two legal matrixes that combine process efficiency with the remedial goals of insolvency legislation to facilitate the speedy recovery of a distressed debtor. This article will review one of the most topical trends in Canadian restructurings, an unconventional restructuring mechanism referred to as a "reverse vesting order" (RVO). Following this, a case scenario in which a debtor with international operations successfully restructured its business in three months will be discussed.
Canada's main restructuring statutes
The two main insolvency statutes in Canada for the restructuring of corporate entities are the Companies' Creditors Arrangement Act (CCAA) and the bankruptcy and Insolvency Act (BIA). Larger companies with at least CAD5,000,000 in debt generally use the CCAA to effect their restructurings. The BIA contains a restructuring regime ("proposal proceedings"), liquidation provisions through the appointment of a receiver (a "receiver"), and a formal bankruptcy process ("bankruptcy").
Plans of arrangement and sales of assets under the CCAA
The CCAA aims at facilitating the compromises and arrangements between companies and their creditors. At its core, the CCAA provides the ability for a company to extinguish claims against it pursuant to a plan of compromise (a "CCAA Plan") on which affected creditors have the right to vote. The party funding the consideration under the CCAA Plan will often receive the totality of the shares of the restructured debtor. For a CCAA Plan to be successful, creditors holding 50% in number and 66 2/3% in value of each class of claims voting on the CCAA Plan must approve the CCAA Plan, and the Court must sanction the Plan as fair and reasonable. Ultimately, the restructured debtor emerges as a financially viable entity with new ownership.
While CCAA plans are the primary restructuring mechanism described in the CCAA, it is also possible to effect a sale of some or all of a business or assets under the CCAA. In fact, sale transactions significantly outnumber CCAA Plans in the current restructuring landscape. The CCAA allows a debtor to dispose of its assets outside the ordinary course of business provided the Court is satisfied with a number of criteria. These elements include whether the process leading to the proposed sale was reasonable, whether the monitor ("monitor") appointed by the court to oversee the CCAA proceedings approves of the process and the sale, and whether the consideration for the assets is fair, reasonable and in excess of the consideration that creditors would receive in a bankruptcy.
In order for a purchaser to acquire assets free of an insolvent debtor's claims ("claims"), the CCAA specifically authorises the court to order that the assets are conveyed free and clear of claims, and that the proceeds of the sale be subject to those claims in the same priority they held vis-à-vis the assets. This type of order is referred to as an approval and vesting order (AVO). While arguments arise from time to time on the type of claims that an AVO can vest out, AVOs are a generally accepted means of implementing a business restructuring.
Reverse vesting orders
At a high level, this mechanism provides for the transfer of unwanted assets and liabilities of an insolvent debtor ("FilingCo") to a shell company ("ResidualCo") pursuant to an order of the court, allowing the cleansed FilingCo to emerge as a solvent restructured entity. To date, RVOs have been used in CCAA, proposal and receivership proceedings. Here the focus will be on circumstances in which RVOs have been used in the CCAA context, their advantages, and the dichotomy between RVOs and the fundamental tenets of the CCAA.
Contrary to an AVO, an RVO transfers the claims of creditors to a ResidualCo (as opposed to transferring the assets to a purchaser, often a single-purpose newly incorporated entity) and allows the restructured FilingCo to emerge from insolvency protection. In that sense, an RVO is the reverse of an AVO. The CCAA does not specifically identify RVOs as a tool available to implement a restructuring. This does not however prevent CCAA courts from approving RVOs using the inherent equitable jurisdiction conferred upon them by the CCAA.
Canadian courts overseeing insolvency proceedings are recognised for using a liberal and purposive approach in interpreting the provisions of the CCAA.
In 2020, the Supreme Court of Canada (SCC) in 9354-9186 Québec inc v Callidus Capital Corp confirmed the broad jurisdiction of the CCAA courts subject only to the restrictions imposed by the CAAA, and the requirement that the order made be appropriate in the circumstances and furthers the remedial objectives of the CCAA. The SCC also identified considerations of appropriateness, good faith, and due diligence as baseline principles.
RVOs were practically non-existent in Canada until the decision of the 2019 Quebec Superior Court in Stornoway Diamond Corp et al (Re). Since then, there have been nearly 20 company restructurings effected via the use of this construct.
RVOs are useful when restructuring an entity that owns valuable assets that are not easily transferable such as licences, public listings or tax attributes (for example, losses or paid-up capital). We are now seeing them frequently in the restructuring of regulated entities such as mining or cannabis companies.
By allowing the existing insolvent corporate entity to retain its assets free of claims, purchasers avoid the risks or prohibitions normally associated with obtaining new licences, permits or accreditations. Similarly, the transfer of tax losses often results in little or no consideration to the creditors of a company, whereas they are often very valuable to the new owner of a restructured entity. Other business practicalities supporting the use of RVOs include avoiding transfer restrictions and consent requirements to the transfer of material contracts.
Time and cost savings
Importantly, the cost and time savings of implementing a transaction through an RVO are significant by contrast to a CCAA plan. An insolvent debtor under CCAA protection who presents a CCAA plan to its creditors must first identify all claims that will be the subject of the compromise. The creditors holding these claims must receive significant notice of the CCAA plan and of the meeting to vote on the plan. As noted above, the court must also sanction the plan. These steps can often take months to complete during which the struggling business continues to operate in an insolvency context.
The stigma, risks and delays associated with lengthy insolvency proceedings inevitably affect the value and viability of an operating business. Since RVOs only require the approval of the court, the restructuring of the operating business can be implemented considerably faster, leaving claim determination, if necessary, to be completed separately after FilingCo emerges from creditor protection.
To date, RVOs have been most commonly used in situations where no creditor opposed, no other alternatives were presented to the court and the value of the claims of unsecured creditors was nil or preserved to be determined at a later point in time.
In late 2020, the Quebec Court in Arrangement Relatif à Nemaska Lithium Inc. ("Nemaska") and the Alberta Court in Quest University Canada (Re) ("Quest") provided lengthy reasons in support of their decision to issue RVOs. Justice Gouin's decision in Nemaska is the first instance in which a Court issued an RVO over the objections of a creditor. At the time of writing this article, there were only two other instances in which a requested RVO was opposed by a creditor. In both Nemaska and Quest, the opposing creditors argued that RVOs deprived them of the right to vote that they would have if the transaction was implemented pursuant to a CCAA Plan. The presiding Courts in both cases commented that those creditors appeared to be using their opposition as a bargaining tool or "working actively against the goals of the CCAA by their opposition to the RVO".
It remains to be seen how far Canadian courts will be willing to go to approve RVOs whether or not they opposed. Commercial courts in Canada with carriage of insolvency cases are sophisticated and pragmatic in implementing the goals of the CCAA. Courts are particularly sensitive to the social and economic consequences that arise when business restructurings fail. When asked to issue RVOs, judges must not only exercise their inherent jurisdiction within the confines of the CCAA but also delicately balance rescuing businesses and employment by contrast to creditors' rights to vote on a fundamental change affecting them.
Selling a business under the CCAA without a court-supervised sale process
Not every sale of an insolvent business requires the running of a court-supervised sales and investment solicitation process (SISP). Some circumstances draw us toward a process though less frequently used is faster and has a higher degree of certainty but requires a strong consensus among the stakeholders. The proceedings commenced by Hematite Holdings Inc and certain related entities (the "applicants" or the "company") in September of 2020 under the CCAA exemplify the non-SISP based sale of a troubled business by way of a CCAA Plan and Chapter 15 of the US Bankruptcy Code (collectively with the proceedings commenced by the applicants under the CCAA, the "proceedings").
Leading up to July 2020, the applicants in the proceedings suffered serious liquidity challenges that required bulge lending from their secured creditors. However, these lifeline loans proved to be insufficient. The COVID-19 pandemic and the resulting government-mandated shutdowns were dragging on and the applicants needed a long-term solution. From March to May of 2020, the company's gross sales were approximately 70% below expectations and it experienced a significant and unexpected operating loss.
In response to this crisis, the applicants privately commenced a search for an investor or buyer that would inject the cash necessary to keep the Applicants' business running and avoid a shutdown of the supply chain that would ultimately impact their automotive original equipment manufacturer (OEM) customers. The applicants narrowed the search down to a single investor/buyer being Woodbridge Foam Corporation (the "sponsor"), a Tier I supplier with:
- the financial means to fund both the proceedings and the bailout transaction; and
- the market credibility and gravitas to provide the stakeholders with confidence and certainty of outcome.
Immediately prior to the commencement of the proceedings, the applicants and the sponsor:
- negotiated CAD6 million in debtor-in-possession financing (the "DIP Loan") and a plan sponsor agreement (PSA) with the sponsor;
- obtained the support of the key senior lender to the applicants and the OEM customers for the proceedings, the DIP Loan and the SPA.
The applicants obtained protection under the CCAA on 18 September listing approximately CAD59.3 million in liabilities owed to secured and unsecured creditors.
The framework of the proceedings and steps towards success
The framework of the proceedings was prescribed by the SPA. Pursuant to the SPA, the sponsor agreed to fund both the DIP Loan plus an amount to be paid to the applicants and used to create a fund to be distributed to affected creditors (the "creditor fund"). The creditor fund would only be distributed to affected creditors if the CCAA plan were approved. On implementation, the CCAA plan contemplated the issuance to the sponsor of 100% of the equity of the parent of the applicants (and therefore indirectly all of the applicants). All pre-existing classes of equity, options and warrants would be cancelled.
For the CCAA plan to succeed, the applicants had to resolve all material outstanding issues with unaffected creditors and stakeholders (principally OEMs and tooling suppliers). This saw a significant number of tooling suppliers being paid in full over time on and after plan implementation. It would also see affected creditors whose claims would be compromised receiving a significant but compromised payment of the Applicants' respective debts to them. The monitor's assessment of the CCAA Plan was that it would provide a better outcome for affected creditors then the alternative liquidation.
Affected creditors voted nearly unanimously in favour of the CCAA plan. Following plan approval by affected creditors and the court, the creditor fund was distributed and the sponsor acquired the applicants. With a cleansed balance sheet, new capital and ownership with the means to put the debtor back in the black, the applicants came out of the proceedings. With careful planning and execution, the proceedings that were commenced on 18 September 2021 resulted in affected creditor approval at a meeting held on 11 December 2021 and plan implementation before year end 2021.
This shift from the prevalent liquidating CCAA proceedings with full blown SISP's to this sort of sale by plan of compromise and arrangement is not likely to be an anomaly. The result in the Hematite CCAA proceedings was made possible by:
- the applicants' desire to see the automotive supply chain not be disrupted;
- the presence of a sponsor that had significant industry influence and credibility;
- OEMs' support based on their desire to avoid the uncertainly, delay and probable supply chain disruption of a SISP;
- sponsor commitment to seeing key tooling supplier relationships kept whole; and
- the co-ordination and co-operation among the sponsor, applicants and monitor and their counsel and financial advisors to hold to a very tight timeline and accept no delay which resulted in an efficient and cost-effective process
Supply chain volatility coming out of the pandemic continues to threaten the automotive sectors and other industries reliant on global supply chains and global steel prices. The probable breakage of these supply chains could have significant upstream impacts. The OEMs in every industry together with their key suppliers may very well turn to faster, more predictable and more cost-effective alternatives to sales processes in order to provide supply chain continuity and health. It is not a trend today but maybe it should be.