Canada: The Québec Court Of Appeal Changes The Allocation Of Realization Proceeds In A Manner Detrimental To A Financial Institution

On February 2, 2012, the Court of Appeal rendered its judgment in the case of Maisons Marcoux Inc. (Syndic de). This marks the Court's first application of article 2754 CCQ in an insolvency context, in which the proceeds of the sale of assets were spread between the secured creditors in an equitable way.

The debtor, Maisons Marcoux Inc. ("Marcoux"), was a business specializing in the manufacturing, sale and installation of pre-fabricated homes. The Caisse Desjardins du Centre de la Nouvelle Beauce (the "Caisse"), financed Marcoux and held conventional hypothecs against all of its assets. Several construction businesses (the "Builders") were involved in Marcoux's Boisbriand project and held legal hypothecs against the project's immovables.

In the spring of 2008, Marcoux was placed under the protection of the Companies' Creditors Arrangement Act (the "CCAA"). The initial court order authorized Marcoux to enter into an interim financing (a "DIP Financing") of $2.1 million guaranteed by a universal "hypothec or security" that would rank as a "superpriority," which is to say that it would rank above all other securities. The Caisse loaned this sum to Marcoux and obtained the superpriority hypothec on all of its assets. However, Marcoux ultimately went bankrupt and its property was subsequently sold. Marcoux then owed the Caisse a total of $5.5 million, of which $2.2 million was secured by the superpriority. The Builders, holding legal construction hypothecs, claimed $1 million. Marcoux's assets were sold by Ernst & Young Inc. ("E&Y") for a sum of $5.8 million, including the immovables related to the Boisbriand, project which were sold under judicial authority for $1.2 million.

The scheme of collocation prepared by E&Y provided that the Builders' legal construction hypothecs ranked below the Caisse's superpriority, which meant that the Builders would receive no repayment on their claims from the sale of the Boisbriand project. The Builders therefore contested this scheme of collocation and asked for a judicial declaration ranking their legal hypothecs ahead of the Caisse's superpriority.

In first instance, the Superior Court ruled in favour of the Builders. The judge of first instance found that, barring the intervention of the court, the superpriority would effectively rank above the claims guaranteed by the Builders' legal construction hypothecs because this was expressly what the initial order had provided and the courts have jurisdiction to derogate from the ranking provided by the Civil Code Québec (the "CCQ") by virtue of the powers conferred upon them by the CCAA. The Superior Court concluded that intervention was justified because the Caisse's superpriority claim of $2.2 million was not endangered because the liquidation of the assets raised more than $5.8 million and it would be unfair for the ranking to remain as it was because that would have effectively nullified the Builders' security.

The Court of Appeal confirmed that courts have the authority to create superpriorities ranking above all other securities due to the powers conferred upon them by virtue of the CCAA. However, the Court of Appeal concluded that it had jurisdiction to spread the claims amongst the creditors pursuant to article 2754 CCQ which states that "[w]here later ranking creditors are secured by a hypothec on only one of the properties charged in favour of one and the same creditor, his hypothec is spread among them, where two or more of the properties are sold under judicial authority and the proceeds still to be distributed are sufficient to pay his claim, proportionately over what remains to be distributed of their respective prices." In the present case, even though Marcoux's assets were liquidated under two separate methods, the immovables related to the Boisbriand project were sold under judicial authority while the remaining assets were sold by E&Y; the Court of Appeal concluded that, given that both types of sale ultimately resulted in the liquidation of Marcoux's assets following the bankruptcy, it could apply 2754 CCQ since the E&Y sale was concluded "under judicial authority" within the meaning of said article.

As stated, the liquidation of Marcoux's assets raised $5.8 million, of which $1.2 million (or 21 per cent) related to the Boisbriand project. Through the pro-ration of the repayment of the $2.2 million secured by the superpriority pursuant to article 2754 CCQ, the Caisse was repaid $462,000 from the sale of the Boisbriand project and $1,738,000 from the sale of Marcoux's other assets. Given that the Caisse's conventional hypothecs ranked after the Builders' legal construction hypothecs, the Builders received an amount of $438,000 to share amongst themselves despite the existence of the Caisse's superpriority. This broad reading of article 2754 CCQ means that, in retrospect, the Caisse would have been better off taking a superpriority solely on the Boisbriand project.

Finally, the Court of Appeal concluded that the marshalling principle, which provides common law courts with the power to favour later ranking creditors when distributing the proceeds of sale of secured assets, does not apply under Québec law.

Ultimately, the Court of Appeal arrived at a mitigated judgment that did not permit the Caisse or the Builders to obtain full repayment of their secured claims pursuant to the scheme of collocation established by the Court. We await with interest, as this judgment may be the subject of an appeal to the Supreme Court by either of the parties.

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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