Canadian – American Cooperation in Cross-Border Insolvencies

Economic and Legal Background

Allow me to turn to an example of how Canada has cooperated with the U.S. in the insolvency field – with the result that value has been maximized and scarce resources utilized and not squandered. Harmonization has been to the advantage of both sides. As with the economic elements involved in globalization in the sense of the parties enjoying the benefits of trade liberalization through the removal (or lessening) of tariffs and non-tariff barriers, so too in the legal sector, parties / countries on all sides of any border benefit from the elimination or lowering of legal barriers so that insolvencies / reorganizations can proceed in the most efficient and effective way and in a timely fashion.

Insolvency is a condition which is inherently chaotic. With the effluxion of time and no stabilization of distracting factors, value evaporates. Resources are not fully utilized – indeed in some instances, the scarce resources are completely discarded. Often these resources are intangibles – namely the goodwill which is built up in a business organization and its workforce. This is not the goodwill that enhances the value of a business by its location, say a newsstand in a subway station. Rather it is the goodwill which a business has arising out of a trained workforce, with established ties to suppliers and to customers and with an organized distribution system. Time, experience and capital have been spent in building up such an organization. While this organization has become insolvent, and therefore there will have been a combination of internal and external factors contributing to such condition, it would be a waste to have the business shut down and its tangible assets liquidated on a piecemeal basis. That result would not maximize value for the creditors of the company (nor for its shareholders); it would throw its employees out of work requiring them to seek jobs for which they may not be readily qualified; it would require anyone purchasing piecemeal assets to rebuild the goodwill discussed.

There is now general recognition that the sale (or other reorganization disposition) of an insolvent but viable business is the option which should be first explored so as to conserve the scarce resources. That may take the form of compromise of debt (restructuring the balance sheet) with creditors exchanging part of the money owed them into equity, possibly with existing management continuing and possibly with the original shareholders maintaining a (reduced) equity participation. At the other end of the spectrum, the company may be taken over by a new equity investor who will require new management and the original creditors may have sold their debt position to entrepreneurial "vulture funds" which may be counting on a reorganization plan leaving them with a return of more pennies on the dollar than they paid the original creditors, with or without an equity kicker. Existing management may survive if it is perceived that the troubles which beset the enterprise were unexpected by the industry generally; if however existing management were not alert, then their chances of survival are minimized.

If productivity is a fundamental problem, then a balance sheet restructuring will only be a temporary bandaid doomed to failure. Productivity issues require a complete rethinking of the business organization/operation so that the restructured enterprise may be competitive. There must also be a recognition that the "successful restructuring" of an enterprise may only increase the pressure on its domestic competitors which may then find themselves next in line for insolvency proceedings. That is, there may be overcapacity in an industry sector which cries out for reduction rationalization. The equation may be more difficult to handle with foreign competition.

Can every insolvent enterprise be successfully reorganized/rehabilitated? No. In some instances, technological innovation will have overcome some industries. Amalgamated Buggywhip Inc. may have been a darling of the stock markets in the 1880’s but with the advent of the automobile its role as a survivor would be as a small niche player catering to horse fanciers. Some businesses transition themselves – e.g. Studebaker from wagons to automobiles – only to succumb to competition from other vehicle manufacturers a half a century later. Today, with the tariff barriers eliminated or virtually non-existent, foreign imports created increasing pressure on domestic industries. Witness the traditional Big Three vehicle manufacturers. Worldwide overcapacity in the vehicle manufacturing business of some twenty percent virtually assures that at some stage, one or more of the Big Three will disappear.

The economic doctrine of comparative advantage in the long run means that everyone in the world, no matter what country they live in, will be better off if there is specialization in those businesses. That a nation or a region has a comparative advantage (taking into account transportation costs). Simply put, if China is more efficient than Canada both as to the production of clothing and of automobiles, but relatively more efficient at doing clothing than automobiles, then both countries would benefit if China produced all the clothing for both countries and Canada all the autos. However we do not live in a perfect world and governments decide for public policy reasons that they wish to support a variety of businesses. But in doing so, these governments subsidize relatively inefficient industries and the worldwide consumer is penalized. We do however live in the short run, not in the long run. It is not easy nor indeed possible to readily change a textile mill into an operation which produces carburetors. Industries which prospered under a cheap Canadian dollar may have difficulty adjusting to its newfound strength (or conversely, the newfound weakness of the U.S. dollar), especially when the change was generally unanticipated and so rapid. Many businesses are capital intensive and require many years to emerge from the planning stage to that of full-scale production; a commitment to such an enterprise requires assumptions as to exchange rates, government policy including taxation, inflation and interest rates.

Developing nations may not find it desirable to rely upon one or two primary industries where they have a comparative advantage. For instance, sisal may be cyclical as to production/harvest and as to price competition on a worldwide basis – and it may be under functional competition with, say, plastic rope. Further these developing nations may feel that they need to protect local inefficient industry for a period of time to allow these industries to achieve a critical mass with which to withstand international competition. Short-term subsidies for this purpose may be acceptable, but if they go beyond a legitimate short-term boost, then they become a hidden tax upon the consumer and a direct burden on the taxpayer, meanwhile they signal hope and expectation to other industries that they too should benefit from a hand-up which is in truth a handout.

Business on a worldwide basis is increasingly becoming more and more competitive. At the same time the world economy is becoming increasingly more interdependent. To enjoy the higher standard of living which goes with that, we have to be flexible and adaptable to keep up with that competition. We really do not have a choice of standing still; for if we did, we would be opting out and so becoming poorer.

Canada is a good example of how foreign trade has benefited its economy. NAFTA substantially integrated our economy with that of the U.S. As indicated in Policy Options (Institute for Research on Public Policy; August 2003; Vol. 24, No. 7; options@irpp.org) concerning "Globalization, the Canadian Way" at pg. 3:

In 2002, exports of goods and services accounted for 41 percent of the country’s output. That actually represents a slight decline since Canadian exports peaked in 2000 at 45 percent of GDP. Exports accounted for four new jobs out of five in the Canadian economy between 1993 and 2000.

So globalization isn’t just a buzzword in Canada. It’s about what we do for a living – trade. Most of it, of course, goes to the United States, destination for nearly 82 percent of Canada’s exports in goods and services last year, some $382 billion, or one-third of Canada’s GDP.

Canada and the U.S. are each other’s largest trading partner. Each has substantial investments in the other.

Cross-Border Cooperation in Practice

Cross-border cooperation in legal matters has a firm foundation in the general law of Canada. I observed in ATL Industries Inc. v. Han Eol Ind. Co. (1995), 36 C.P.C. (3d) 288 (Ont. Gen. Div.) at pp. 302-3:

Allow me to start off by stating that I agree with the analysis of MacPherson J. in Arrowmaster Inc. v. Unique Forming Ltd. (1993), 17 O.R. (3d) 407 (Gen. Div.) when in discussing Morguard Investments Ltd. v. De Savoye, [1990] 3 S.C.R. 1077, 76 D.L.R. (4th) 256, 52 B.C.L.R. (2d) 160, 122 N.R. 81, [1991] 2 W.W.R. 217, 46 C.P.C. (2d) 1, 15 R.P.R. (2d) 1, he states at p. 411:

The leading case dealing with the enforcement of "foreign" judgments is the decision of the Supreme Court of Canada in Morguard Investments, supra. The question in that case was whether, and the circumstances in which, the judgment of an Alberta court could be enforced in British Columbia. A unanimous court, speaking through La Forest J., held in favour of enforceability and, in so doing, discussed in some detail the doctrinal principles governing inter-jurisdictional enforcement of orders. I think it fair to say that the overarching theme of La Forest J.’s reasons is the necessity and desirability, in a mobile global society, for governments and courts to respect the orders made by courts in foreign jurisdictions with comparable legal systems, including substantive laws and rules of procedure. He expressed this theme in these words, at p. 1095:

"Modern states, however, cannot live in splendid isolation and do give effect to judgments given in other countries in certain circumstances. Thus a judgment in rem, such as a decree of divorce granted by the courts of one state to persons domiciled there, will be recognized by the courts of other states. In certain circumstances, as well, our courts will enforce personal judgments given in other states. Thus, we saw, our courts will enforce an action for breach of contract given by the courts of another country if the defendant was present there at the time of the action or has agreed to the foreign court’s exercise of jurisdiction. This, it was thought, was in conformity with the requirements of comity, the informing principle of private international law, which has been stated to be the deference and respect due by other states to the actions of a state legitimately taken within its territory. Since the state where the judgment was given has power over the litigants, the judgments of its courts should be respected." (Emphasis added)

Morguard Investments was, as stated earlier, a case dealing with the enforcement of a court order across provincial boundaries. However, the historical analysis in La Forest J.’s judgment, of both the United Kingdom and Canadian jurisprudence, and the doctrinal principles enunciated by the court are equally applicable, in my view, in a situation where the judgment has been rendered by a court in a foreign jurisdiction. This should not be an absolute rule – there will be some foreign court orders that should not be enforced in Ontario, perhaps because the substantive law in the foreign country is so different from Ontario’s or perhaps because the legal process that generates the foreign order diverges radically from Ontario’s process. (My emphasis added)

Comity and cooperation are necessary in the bankruptcy and insolvency context – but also in the context of all cross-border litigation.

In Re Babcock & Wilcox Canada Ltd. (2000), 18 C.B.R. (4th) 157 (Ont. S.C.), a case involving the recognition and enforcement of a U.S. Bankruptcy Code Chapter 11 stay of proceedings as to a solvent Canadian subsidiary (as opposed to an insolvent Canadian subsidiary) of the main U.S. parent applicant in the U.S. proceedings, I indicated that it was appropriate to give the relief requested on a weighing of multiple factors (many of which are relevant to any form of litigation) which I described at pp. 167-8 as follows:

…Relying upon the existing law on the recognition of foreign insolvency orders and proceedings, the principles and practicalities discussed and illustrated in the Cross-Border Insolvency Concordat and the UNCITRAL Model Law on Cross-Border Insolvencies and inherent jurisdiction, all as discussed above, I would think that the following may be of assistance in advancing guidelines as to how s. 18.6 should be applied. I do not intend the factors listed below to be exclusive or exhaustive but merely an initial attempt to provide guidance:
    1. The recognition of comity and cooperation between the courts of various jurisdictions are to be encouraged.

    2. Respect should be accorded to the overall thrust of foreign bankruptcy and insolvency legislation in any analysis, unless in substance generally it is so different from the bankruptcy and insolvency law of Canada or perhaps because the legal process that generates the foreign order diverges radically from the process here in Canada.

    3. All stakeholders are to be treated equitably, and to the extent reasonably possible, common or like stakeholders are to be treated equally, regardless of the jurisdiction in which they reside.

    4. The enterprise is to be permitted to implement a plan so as to reorganize as a global unit, especially where there is an established interdependence on a transnational basis of the enterprise and to the extent reasonably practicable, one jurisdiction should take charge of the principal administration of the enterprise’s reorganization, where such principal type approach will facilitate a potential reorganization and which respects the claims of the stakeholders and does not inappropriately detract from the net benefits which may be available from alternative approaches.

    5. The role of the court and the extent of the jurisdiction it exercises will vary on a case by case basis and depend to a significant degree upon the court’s nexus to that enterprise; in considering the appropriate level of its involvement, the court would consider:

      1. the location of the debtor’s principal operations, undertaking and assets;

      2. the location of the debtor’s stakeholders;

      3. the development of the law in each jurisdiction to address the specific problems of the debtor and the enterprise;

      4. the substantive and procedural law which may be applied so that the aspect of undue prejudice may be analyzed;

      5. such other factors as may be appropriate in the instant circumstances.

    6. Where one jurisdiction has an ancillary role,

      1. the court in the ancillary jurisdiction should be provided with information on an ongoing basis and be kept apprised of developments in respect of that debtor’s reorganizational efforts in the foreign jurisdiction;

      2. stakeholders in the ancillary jurisdiction should be afforded appropriate access to the proceedings in the principal jurisdiction.

    7. As effective notice as is reasonably practicable in the circumstances should be given to all affected stakeholders, with an opportunity for such stakeholders to come back into the court to review the granted order with a view, if thought desirable, to rescind or vary the granted order or to obtain any other appropriate relief in the circumstances.

The stay has now been in place for over three years as the proceedings have been evolving to an anticipated practical solution in the U.S. – and interestingly enough there has been no challenge, objection or questioning of this order in the interim by any affected Canadian interested person using the "comeback clause". It would seem that this lack of further involvement may be taken as a practical approval by those concerned for a common sense solution to a cross-border problem which maximizes the potential for value and minimizes the difficulties of cost.

This has been a short and simplistic economic analysis to set the stage for the legal concerns involved in cross-border insolvencies. In essence, when things go wrong in a business enterprise, there are much more likely to be implications in various countries, including Canada (and likely at least the U.S.). As Bruce Leonard and I observed in a paper to the Turnaround Management Association Conference in 2001 entitled Co-ordinating Cross-Border Insolvency Cases:

  1. The Globalization of Business and the Globalization of Reorganizations and Restructurings

The tremendous advances in information technology within the last fifteen years have made it possible for businesses to operate in a variety of different countries at the same time and to link all of these operations as if they were right next door. A multinational business operating profitably and internationally can make decisions quickly that affect its global operations; it can allocate resources internationally in a manner which best suits its objectives and it can utilize its going-concern values to augment the value of its underlying operating assets on the basis that the whole is greater than the sum of its parts.

The onset of an insolvency case, however, stops all that and turns the business into a series of disconnected segments in several different countries. In a typical international insolvency, different sets of creditors assert different kinds of claims to different assets under different rules in different countries. The international business that was once carried on comes to an end and separate, unconnected remnants of the organization attempt to continue until they either starve or implode. It is almost as if a cross-border insolvency system had been set up deliberately to promote failures and liquidations.

The structural framework for dealing with multinational and cross-border businesses that encounter financial difficulties has hardly evolved from the state it was in several decades ago although our recent experience and developments that are on the horizon hold the promise of significant improvements and the prospect of the domestic adoption of the UNCITRAL [United Nations Commission on International Trade Law] Model Law is becoming more and more encouraging. There have been initial and limited domestic legislative initiatives into the area of co-operation in international insolvencies and restructurings but until the UNCITRAL Model Law is widely enacted, however, the legal structure internationally for enterprises in financial difficulty can best be described as compartmentalized. When insolvency or financial failure affects a multinational business, it is still most commonly dealt with through a variety of independent, separate and often-unconnected administrations, most often for different, if not conflicting, purposes.

For reason of simplicity, I will only refer to a two country Canada - U.S. model; however, in many instances there will have to be more than two countries involved – e.g. ranging from three, Canada, U.S. and England, in the Olympia & York insolvency to scores in BCCI (Bank of Commerce and Credit International) to over 150 in Singer.

What happens when things go awry in a business that operates and/or has investments on both sides of the border? Usually there will be filings on both sides of the border – Chapter 11 of the U.S. Bankruptcy Code and usually the Companies’ Creditors Arrangement Act (CCAA) in Canada. If the activity in the U.S. is fairly derivative of what might be described as a main centre of activities in Canada, then likely, a s. 304 U.S. Code ancillary proceeding will be brought in the U.S. to stay proceedings there and coordinate them with the main Canadian proceedings. In the reverse situation, the s. 18.6 1997 amendments to the CCAA (or indeed Part XIII of the Bankruptcy and Insolvency Act (BIA)) may be utilized to the same effect. As a side note, historically and now, the U.S. is used to having a Chapter 11 stay respected essentially on a worldwide basis because so many foreign enterprises have U.S. investments or their principals travel to the U.S. In contrast many foreign enterprises may be willing to run the risk of ignoring a stay order emanating from a Canadian or other non-U.S. court on the basis of having no tangible connection with the country whose court has issued the stay. An example of this would be the seizure of Canada 3000 Inc. planes in Europe by creditors notwithstanding Ground J.’s CCAA order. In those types of circumstances, Canadian CCAA applicants would have to obtain foreign recognition of the Canadian order usually on a comity basis so as to allow for practical enforcement. That process may take some time – in which case as illustrated by Canada 3000 - the horse will have been taken from the barn. However, at present, it is not unusual for foreign-retained counsel to be waiting by the fax machine for a copy of the CCAA order so that they may obtain a recognition order within a few hours from the U.S. or other major trading partner court, with that recognition order having effect for the whole of the day of issue. Allow me to observe that the Courts of Canada and the U.S. are very cognizant of the doctrine of comity and further that the increased volume of proceedings traffic across the 49th parallel has resulted in that familiarity allowing for significant streamlining of applications.

Given that the insolvency condition is inherently chaotic, then most of the proceedings are manifestly "real time litigation". However, part of a case may evolve into what might be termed "autopsy litigation"; an example of this would be where there is no contention amongst any of the interested parties that a particular segment of the enterprise be disposed of with the result that it may be transferred to the new owner without dispute in exchange for value but that autopsy litigation may take place, say, a year later as to how that consideration is to be divided up. The important thing with real time litigation is not to get bogged down in procedural issues, but rather that coordination between the jurisdictions be coordinated to the maximum degree. The fundamental cornerstone of that coordination is to have effective and timely communication between the courts of the two (or more) jurisdictions. How is that to be accomplished?

Communication between courts – is that not a radical step? Are there no fundamental issues of procedural fairness involved? The answer is no to the first question and yes to the second, but that procedural fairness questions have been well addressed over the past decade. There has always been communication between courts – in the past this has usually been through one court issuing an order accompanied by reasons and the other court responding in kind with communications being through counsel in either jurisdiction. However, this is rather time consuming and it does not lend itself to brainstorming problems/solutions in real time.

The need for better, that is more efficient, communications was well illustrated by the Maxwell Communications case of the early 90s. The U.S. and English judges, Brozman and Hoffmann respectively, sensed that the information they were receiving in their respective courts was askew. They independently raised with their respective counsel that a protocol between the two courts would be helpful, not only to resolve an impasse, but also to facilitate better and more timely exchange of information. Interestingly enough with the protocol in place which provided for an intermediary, these two distinguished judges never spoke directly to each other until they met for the first time at an international insolvency conference shortly after the successful conclusion of the Maxwell case. Needless to say that they have become fast personal friends.

About the same time in the Olympia & York proceedings, there was a problem involving governance of the O&Y U.S. subsidiaries. Again a protocol was worked out and accepted by Chief Judge Lifland of the New York Bankruptcy Court and Justice Blair of the Ontario Court. It involved the introduction of another intermediary, the distinguished U.S. diplomat Cyrus Vance who was able to facilitate a modus vivendi.

The Maxwell and O&Y protocols were what might be described as single purpose limited in scope arrangements between the courts. With the appreciation that protocols could, if carefully thought out and responsive to each jurisdiction’s needs, eliminate value evaporating wastage of time, practitioners in several countries including Canada thought that it would be helpful to provide an acceptable building block menu of principles to assist those involved in transborder insolvencies to finalize "general" protocols. The philosophy was that good fences / good bridges make good neighbours. Under the auspices of the International Bar Association, a working group of teams from more than a score of countries reviewed the commonalties of their insolvency regimes. This project involved major jurisdictions whose insolvency laws and procedures were based upon common law, civil code and mixed or other principles. While English was the working language, there was recognition that the principles had to be expressed in absolutely neutral language readily translatable into other tongues and legal concepts, thereby avoiding any actual or perceived bias towards the common law. The threat of unintentional bias was quite real since the judiciary in common law jurisdictions, especially the U.S., England and Canada, had considerably more experience in international judicial cooperation and in this respect had generally utilized the common law philosophy that if something was not forbidden and it made sense to do it, then it was judicially permitted. Key also to the working group success was the participation of judges along with practitioners from the outset of the project. The IBA project culminated with that body’s adoption in September 1995 of the principles under the title of "Concordat". The international insolvency community benefited not only from the availability of the Concordat principles, but also from the working sessions allowing the various persons involved to discuss the underlying concerns and commonalties, engage in give-and-take discussions based upon the experience gained in previous cases and to "get to know the other fellows".

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