In 2015, Justice Wilson-Siegel approved a new form of vesting order, referred to as the "reverse vesting order" (or RVO) as part of the restructuring in Plasco Energy (Re). An RVO is a court order that transfers unwanted assets and liabilities out of a debtor company into a (oftentimes newly incorporated) affiliated company, referred to as "ResidualCo." The debtor company is left holding only the assets and liabilities the purchaser wants to acquire. The debtor company then emerges from the Companies' Creditors Arrangement Act proceeding, typically by way of an acquisition of its shares by the purchaser, while ResidualCo remains in the proceeding and typically makes an assignment into bankruptcy. (This is in contrast to an AVO – an AVO transfers wanted assets and liabilities out of the debtor company to the purchaser; an RVO transfers unwanted assets and liabilities out of the debtor company.)
The court approval of RVOs has increased substantially since 2015, and without much scrutiny, until Justice Penny's caution in Harte Gold Corp (Re), 2022 ONSC 653 that the use of RVO structures "should continue to be regarded as an unusual or extraordinary measure."
Recently, In the matter of CannaPiece Group Inc et al, 2023 ONSC 841, for the first time in Ontario since the Court's guidance in Harte Gold, Justice Osborne refused to grant an approval and vesting order that included an RVO, principally because granting the order would make a first ranking secured creditor materially worse off. Cliff Prophet, Heather Fisher, David Cohen and Haddon Murray acted on behalf of 212, the opposing creditor.
CannaPiece ("CPC") operated a cannabis manufacturing business. It had two main creditors: 212, which advanced funds for the purchase of manufacturing and processing equipment, secured against that equipment, and Marzilli, who advanced funds secured against all of CPC's assets, carving out 212's existing security against CPC's equipment.
In November 2022, CPC sought and received CCAA protection. At the time, CPC owed 212 approximately $4,000,000, and owed Marzilli approximately $6,800,000. Thereafter, the court approved a SISP featuring a stalking horse share purchase agreement between CPC, as vendor, and Cardinal Advisory Services, as purchaser (the "Stalking Horse Bid"). Cardinal also agreed with 212 that Cardinal would assume the 212 debt, pay $500,000 to 212 within six months of the SPA closing, and issue shares in CPC to 212 (the "Assumption Agreement"). On the strength of its agreement with Cardinal, 212 did not oppose the approval of the sales process.
Subsequently, Marzilli submitted the only other bid in the sales process (the "Marzilli Bid"), comprising a cash component of $4,000,000 plus assumed liabilities, including the assumption of the Marizilli debt. It did not include an assumption of the 212 debt.
Due to the centrality of certain cannabis licences to CPC's operations, all parties agreed that an RVO would be necessary to preserve the going-concern value of the business. The effect of the reverse vesting in the circumstances would be that, depending on which bid was successful, either 212 or Marzilli's security interest would be transferred to a ResidualCo with little hope for recovery. The monitor, after consultation with CPC, selected the Marzilli bid as the successful bid.
CPC applied for approval of the Marzilli transaction, including an RVO vesting the 212 liabilities in ResidualCo. 212 opposed the application.
Justice Osborne applied the "cascading analysis" of factors that the Court of Appeal for Ontario prescribed in Third Eye Capital Corporation v Dianor Resources Inc., 2019 ONCA 508 to determine whether 212's interest should be extinguished by a vesting order:
- The nature and strength of the interest to be extinguished: 212's interest was significant despite the fact that it was limited to the equipment to which its security applied. Its interest ranked in first position over that collateral. As a practical matter, an order transferring 212's rights to ResidualCo would effectively extinguish those rights in light of the limited prospects of recovering from ResidualCo. Notably, Justice Osborne rejected the view that the Third Eye factors only apply to interests in land or other proprietary rights.
- Whether the interest holder has consented to the vesting out of their interest: 212 had not consented to the vesting out of its interest. Justice Osborne rejected the submission that, through entering into an Assumption Agreement with Cardinal, 212 had consented to a vesting out of its interest. Rather, the Assumption Agreement meant that the assumption of 212's debt formed part of the Stalking Horse Bid.
- A consideration of the equities to determine if a vesting order is appropriate in the circumstances: In light of 212's first ranking security interest and the fact that the assumption of 212's debt formed part of the consideration in the Stalking Horse Bid, Justice Osborne found that the equities favoured refusing to approve the reverse vesting order.
In light of these conclusions, Justice Osborne declined to grant the proposed vesting order.
CannaPiece may reflect a growing view on behalf of Ontario courts that RVOs should be carefully scrutinized. The decision also highlights the analysis required to determine what constitutes a superior bid in a stalking horse process. As noted by Justice Osborne, on the facts before him, the conclusion that the Marzilli Bid was superior was "challenging."
The proposed RVO at issue in Cannapiece included two factors that Justice Penny marked as indicia of unfairness in Harte Gold: (i) it was uncertain whether the proposed RVO produced an economic result at least as favourable as any other viable alternative; and (ii) 212 was worse off under the RVO than it would have been under the Stalking Horse Bid. As Cannapiece shows, the focus remains on what is fair and reasonable in the context of the case.