Originally part of a 44 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 2022 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 44 jurisdictions.
The section on "Trends and Developments" for the Canadian jurisdiction, which focuses on condominium development projects and litigation financing, was authored by David Cohen, Geneviève Cloutier and Patrick Cajvan.
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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
Dealing with distressed condominium development projects
Author: David F.W. Cohen
It is no secret that one of the first segments of the Canadian economy to be impaired by inflation was the construction sector. Nowhere was this more obvious than in the condominium development industry. Which projects were in trouble depended on the timing of the development.
COVID-19 pandemic lockdowns began in Ontario (and across Canada) in mid-March 2020, straining the resources of developers and inevitably leading to significant and costly delays. Other consequences of the pandemic on the construction sector included the following.
- The municipal government approval process slowed to a snail's pace during the pandemic as staff worked from home.
- Construction sites were intermittently shut down following pandemic safety protocols.
- The global logistics crunch brought shipping to a grindingly slow pace, causing increased delays in the shipping of raw materials and finished products.
- The restricted shipping resulted in the cost of shipping increasing at an alarming rate.
- Raw materials and product pricing began to rise at alarming rates – including steel, timber and rubber.
- Subcontractors, rendered idle by the delays, began to walk away from contracts with the developers. These subcontractors were seeking better contract pricing with other projects or were renegotiating their pricing under an existing contract to account for inflation and the impact of the delays.
- Labour shortages started to hit home.
If a given project was pre-sold in 2018 and 2019 with construction commencing in late 2019 and early 2020, the pandemic was a perfect storm of delays, labour shortages and input cost escalation. Developers had pre-sold these projects into a hot condominium market at prices derived from 2018 and 2019 construction budgets. Condominium prices were continuing to climb even through the pandemic – at least while low interest rates held.
These developments were "out of the money." Indeed, if the developers completed the project they were destined to lose money – a lot of money. Yet market prices for condominiums continued to increase, or at least remained at all time high levels.
At the risk of oversimplifying what is a complex web of relationships, the stakeholders include:
- the developer;
- the construction manager;
- the sub-trades;
- the real estate broker;
- the secured construction lender;
- Condominium Escrow Deposit Bonds (surety bondholders);
- the unit buyers;
- Tarion (the quasi-government body protecting unit buyers); and
- excess deposit insurers.
Broadly speaking, a challenged developer had a few choices: (i) complete the project, close on the sale contracts with the unit buyers in accordance with their unit sale contracts, and take the loss; (ii) shut the project down and be in breach of contract with the unit buyers, potentially resulting in a bankruptcy; or (iii) file for creditor protection and make a proposal to the unit buyers. For restructuring professionals engaged by developers, it was this last alternative that was of greatest interest because it gave them an opportunity to reprice their project or convert it from a condominium project to a rental property project. One necessity was that the financially challenged project could not be co-mingled in the same corporate entity with financially healthy projects since one cannot selectively file only part of a business for protection or reorganisation.
There were a number of cases that ensued under the proposal provisions of the Bankruptcy and Insolvency Act (Canada) (BIA) or the Companies Creditors' Arrangement Act (Canada) (CCAA). The typical features of these cases included the following.
- The developer (likely a single-purpose company holding the financially challenged condominium project) would file for protection under the CCAA.
- The developer would stabilise the project by securing debtor-in-possession (DIP) financing which would normally not prime the position of the secured construction lender.
- The secured construction lender, which had likely frozen the pre-filing construction financing when the cost-to-complete budgets ballooned resulting in covenant breaches, would be stayed from taking enforcement steps. Since the new money was flowing in at a lower priority, as long as the project was being completed they were (sort of) happy. Their risk was the failure to complete construction and close on the unit sales.
- Sub-trades would not be compromised and the DIP loan would be used to keep the construction project running.
- A "representative counsel" for the unit buyers might be appointed by the developer to make negotiations with the unit buyers easier. Unit buyers could seek their own counsel rather than representative counsel, but they would have to fund that cost and opt out of the representative counsel order quickly.
- A plan would be presented to the unit buyers that would offer one or both of the following:
- unit buyers' deposits would be returned with a premium added to entice the unit buyers to take that option; and/or
- unit buyers would be able to purchase their unit at an amended higher price that gave the developer back its profit (or at least eliminated the developer's loss).
- In some instances, the developer would not provide the increased purchase price option since the developer wished to take the entire project as a rental property project and terminate the development as a condominium project. In that case, the unit buyers would only be offered the return of their deposit on a timely basis plus a likely larger premium to ensure the unit buyers supported the plan.
In most instances, a heated negotiation would occur between the developer and the unit buyers over the deposit premium and/or the unit purchase price increase. The developer might also agree to share profit with unit buyers above a certain level. The result has been that these types of plans have been approved, and the projects completed and either sold at higher prices or converted to rental properties. The developers have avoided a loss (and potentially made a profit) and the unit buyers see their deposits returned with a premium or, in some cases, got to buy their unit, albeit at a higher price. The sub-trades, the real estate brokers, the secured construction lender, the DIP lender or the surety bondholder have suffered no losses.
It is worth noting that this restructuring solution only makes sense if the market price for the units has appreciated since the pre-sales were booked. If the market prices for the impaired condominium project have declined, it is more likely that a receivership model would be used, resulting in more of those stakeholders losing money. Unit buyers would not be interested in closing their transactions, making the economics of a restructuring undesirable. Indeed, if the market were to go upside down, the secured lenders might be rushing to complete the project and close the sales with the unit buyers (assuming the unit buyers do not default and walk away from their obligations) in order to avoid deeper losses.
As of the date of writing of this article, the condominium market in Ontario is showing softening as interest rates rise. The window may be closing on this solution for now.
Litigation financing in the context of insolvency matters
Authors: Geneviève Cloutier and Patrick Cajvan
Litigation financing is still in its early stages in the province of Quebec. The province has been reluctant to accept this method of financing. Recently, however, courts have seen this alternative funding model in a new light. In 2010, the Right Honourable Lord Rupert Jackson of the House of Lords conducted a comprehensive inquiry into the costs of civil litigation. In his report entitled Review of Civil Litigation Costs, Lord Jackson, among other things, refers to "third party financing" as a tool for access to justice. Litigation financing is now commonplace in the context of class actions in the province of Quebec as well as elsewhere in Canada. More recently, such agreements are spreading to commercial matters such as in insolvency matters.
The first major case in the context of a CCAA proceeding was that of Callidus Capital Corporation and Bluberi Group. The parties appealed to the Supreme Court, which notably decided that litigation funding can be approved as interim financing following a case-specific inquiry. To receive this approval, the litigation funding needs to further the preservation and realisation of the value of a debtor's assets. The litigation financing agreement must not contain terms that effectively convert it into a plan of arrangement.
The case of Fortress Global Enterprises Inc. also gained much attention in Quebec. Fortress operates a dissolving pulp business and renewable power co-generation facility in Thurso, Quebec. Two of Fortress's secured creditors initiated a CCAA proceeding. Litigation financing was sought by the debtor to pursue a CAD17 million claim the company had filed against a third party before the CCAA proceeding. The first judge refused to issue an order approving the litigation funding agreement since it allowed the litigation funder to terminate the litigation funding agreement in advance of an adverse costs award and did not ensure that eventual adverse costs would be honoured. A few weeks later, the parties sought once again the approval of the Court, which was yet again refused as the Court was not satisfied that the terms of the agreement provided for a proper notice of termination of the agreement to the adverse party. As the CCAA process offers more flexibility and greater judicial discretion than the rules-based mechanism under the BIA, the Court remained open to further representations, which finally led to the approval of the litigation funding agreement with further amendments.
We do not yet know the place litigation financing will have in the Quebec legal system, but we see from recent case law that courts have embraced this means of financing.