Canada: Flash: Ontario Court of Appeal Decision Fundamentally Changes Corporate Restructuring Landscape

Indalex Limited's assets were sold in a liquidating proceeding under the federal Companies' Creditors Arrangement Act (the "CCAA"). Indalex administered defined benefit pension plans which had substantial deficiencies at the time of the filing, although the company was up to date in making all statutorily mandated payments. Former employees and the union asserted priority claims over the sale proceeds in respect of Indalex's pension plan deficits giving rise to the question: Does the statutory deemed trust under Ontario's Pension Benefits Act trump the Court ordered super-priority charge typically granted to a debtor-in-possession ("DIP") lender inside CCAA proceedings? Shockingly, the Ontario Court of Appeal's answer was: "Yes".

That answer, however, was still not the most concerning aspect of its decision. The Court of Appeal also held that where a debtor has breached its fiduciary duties1 to the pension plan beneficiaries, then the Court may find that a "constructive trust" applies to the debtor's property (such as the proceeds resulting from the sale of its business) and, therefore, such property (or sale proceeds) must be used to fund the full amount of any pension plan deficiencies first ahead of anyone else — whether or not the statutory deemed trust applies to such pension obligations. In addition, the Court of Appeal stated that a voluntary assignment into bankruptcy should not be used to defeat a secured claim under valid provincial legislation and, in particular, that: "it is inappropriate for a CCAA applicant with a fiduciary duty to pension plan beneficiaries to seek to avoid those obligations to the benefit of a related party by invoking bankruptcy proceedings when no other creditor seeks to do so."

The decision suggests that the priority question can be addressed by clearer and more explicit priority language being drafted into CCAA orders pertaining to DIP financing than currently exists under the model orders prescribed by the Ontario court. However, to grant such an order, the CCAA Court must find that the recognition of the pension deemed trust would frustrate the purpose of the CCAA proceeding and therefore explicitly invoke the paramountcy of the CCAA (which is federal legislation) to grant a super-priority charge over a trust created under a provincial statute. This will necessitate providing evidence in DIP financing motions that the financing will not be made available (or otherwise materially more onerous) without the ability to trump the pension deemed trust. This may be tricky to do under recent CCAA amendments dealing with DIP financing and the definition of "secured creditor" under the CCAA. Further, any motion to approve the DIP priority must be on notice to the affected pension beneficiaries. Giving such notice may be problematic particularly if funding is needed on the first day. However, if successful, the end result would be to put DIP lenders back to the spot where they believed they were prior to Indalex and, therefore, resolve at least part of the problem.

The larger issue — avoiding a breach of fiduciary duty finding that leads to a constructive trust remedy of paying out all pension plan deficiencies first — will be considerably more difficult (if not impossible) to address. Furthermore, this issue affects all creditors with claims against a debtor's assets, not just DIP lenders and, therefore, will impact credit markets generally. And, while an argument exists to distinguish Indalex on its facts,2 relying on the ability to successfully distinguish Indalex will likely be cold comfort to any lender until there are a number of cases clearly recognizing the distinction.

Where an employer is also the pension plan administrator (as is almost always the case with single employer plans in Ontario), it is very difficult to see how such an employer can implement a CCAA restructuring without being held to then have breached its fiduciary duties to pension plan beneficiaries as plan administrator. While the Court of Appeal did hold that the decision to commence a CCAA proceeding was not part of the administration of the pension plan nor does it necessarily engage the right of the beneficiaries of the pension plan, it did allude to the following factors in considering whether or not a breach of fiduciary duty occurs: doing nothing in the CCAA proceedings to fund the deficit in underfunded plans; taking no steps to protect the vested rights of the plan beneficiaries to continue to receive their full pension entitlements; applying for CCAA protection and obtaining the CCAA order that provided the super-priority charge in favour of its DIP lender without notice to the plan beneficiaries; selling assets without making any provision for the plans; doing nothing to protect the best interests of the plan beneficiaries; and, basically, ignoring its role as pension plan administrator3 and focussing solely on its general duties to stakeholders.

Of course, if a debtor attempts to fund a plan deficiency (in cases where the deficiency is not subject to the statutory deemed trust) in preference to its other creditors, that action will likely be attacked as not only being a fraudulent preference but possibly also oppressive conduct. The Monitor, the CCAA Court's officer, would likely not sanction such payments. Insolvency law requires that the debtor preserve the status quo standing of all creditors at the date of filing so that no one creditor can obtain a "leg up" on other creditors of the same class. As of the CCAA filing date, any deficit in an ongoing pension plan would be an unsecured claim which should share pro rata with all other unsecured creditors as of the filing date. Accordingly, a CCAA debtor essentially cannot engage in actions that prefer one pre-filing unsecured creditor over another - yet, this decision suggests that if the CCAA debtor does not attempt to engage in such conduct it will be seen as being in breach of its fiduciary duties as plan administrator. Furthermore, even if a debtor wished to have someone independent appointed as the plan administrator just prior to or shortly after a CCAA filing, it would be very difficult to do so. As such, debtors (and their creditors) have now been placed in an impossible position with no apparent way out.

The Court's holding that attempting to deal with the priority issues by bankrupting a CCAA debtor once the assets have been sold is essentially impermissible creates further uncertainty. Secured lenders to Canadian debtors have long relied on plan deficits being unsecured claims in a bankruptcy when determining the amount of borrowing availability to provide a debtor. Prior court decisions had approved of debtors converting CCAA proceedings into bankruptcies to alter priorities. This reliance is now in question if the bankruptcy is preceded by a CCAA filing as is often the case.

It is expected that Canadian credit markets will be reacting with caution to the Indalex decision until it is clarified by future case law or legislative amendments, and debtors inside or contemplating CCAA proceedings will need to find ways of ensuring that the "breach of fiduciary duty as plan administrator issue" is not visited upon them.

Footnotes

1. Because Indalex acted as administrator of its pension plans it had fiduciary duties to the beneficiaries of the plans.

2. By arguing that such a result really only applies where the beneficiary of the security that is to be enforced is a related party that effectively controlled the decisions of the CCAA debtor and, thereby, was the party in effect breaching the fiduciary duties (as it was effectively Indalex's U.S. parent invoking the DIP charge in this case having paid out on a guarantee to the DIP lender). There may be a trend to creditor imposed filings in order to avoid this issue.

3. It is noted that Indalex's filing always contemplated a liquidation of the business and there was never any prospect that the company would be restructured and that the pension plans would continue.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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