You are probably aware of the useful restructuring and creditor protection process available to insolvent entities in the United States under Chapter 11 of the United States Bankruptcy Code. In Canada, more than one insolvency regime is available in respect of debtor companies in financial difficulty and those interested in acquiring such companies or their assets. However, because of its flexibility, the most commonly used Canadian regime for larger debtor companies or complicated restructurings is the Companies' Creditors Arrangement Act (Canada) (the "CCAA").
Use of the CCAA can benefit both (i) insolvent debtor companies seeking to restructure themselves while protected from their creditors and (ii) buyers interested in obtaining the assets of distressed companies on favourable terms and without some of the procedural hurdles imposed in other M&A transactions.
In this article, we have focused on the second of these two categories of benefits – what the CCAA can do for M&A transactions. We will highlight those benefits and then briefly explain what the CCAA procedure involves.
Key Benefits of the CCAA
Broad Judicial Discretion
Judges supervising proceedings by a debtor company under the CCAA have broad powers and discretion to allow insolvent companies protection under the CCAA to deal with their assets. This broad discretion can allow for business combinations and asset sales to occur that might otherwise not be possible.
Safe Haven for Directors of Distressed Companies
The directors of distressed companies face profound business difficulties, which are compounded by the need to act speedily within a dense thicket of fiduciary and statutory duties. Central to these difficulties is the inability of the debtor company to continue operations so as to realize or preserve the "going concern" value in the insolvent business that would likely be lost in a bankruptcy. If a distressed company's management is of the view that a sale of all or a part of its business is the best choice, this may not be possible in the available time or on terms acceptable to potential acquirors if unpaid creditors intervene or if shareholder approvals and regulatory or other third party consents are first required. The CCAA offers the management of troubled companies a clear, judicially blessed (i) stay of proceedings by creditors and others, (ii) ability to continue operations, (iii) time to work out a "fair and reasonable" restructuring of the business, and/or (iv) time to arrange for a beneficial and expedited sale of assets or shares outside of bankruptcy.
Directors and officers still remain in control of the debtor company during CCAA proceedings (albeit under the watchful eye of the court approved monitor) and thus must remain cognizant of their fiduciary and statutory duties. Management can legitimately ask for and receive protection going forward as an incentive to remain with the company during the process and CCAA orders often include indemnification for them.
Safe Haven for Acquirers of Distressed Assets
The purchase of a distressed company or business can be equally
challenging for a perspective investor or buyer. Investment in a
faltering business may leave the investor ranking behind other
creditors in a bankruptcy. Rights acquired in distressed assets may
be judicially overturned as unfair to creditors. The CCAA
a judicially blessed transaction, free from many later types of challenge ― giving certainty and greatly reduced risk to those interested in purchasing distressed companies or their assets.
Asset Sales under the CCAA
In the normal course, the sale by a Canadian corporation of all or substantially all of its assets requires the approval of its shareholders by special resolution and may require other filings, approvals or consents (for example, those of stock exchanges, government authorities, joint venture partners or other contracting counterparties). The CCAA can facilitate obtaining such approvals or may obviate the need to obtain such approvals.
Pursuant to the CCAA, the court has the statutory authority to approve a sale of the debtor company's assets, free and clear of any security, charge or other restriction. The sale can occur during the CCAA process either as a means to finance a restructuring of the remaining assets of the debtor company or as the final creditor-approved outcome of the CCAA proceedings. While the courts prefer to see a sale of a business as a going concern, judges may also approve CCAA asset sales in a more piecemeal fashion, even where that may have the effect of liquidating the debtor company.
When deciding whether to approve the sale, the court is required to consider, among other things, whether the process leading to the proposed sale was reasonable in the circumstances, whether the CCAA monitor approved the process, the effect of the proposed sale on creditors and other interested parties and whether the consideration to be received is fair and reasonable, taking into account fair market value.
Share Sales under the CCAA
An alternative to the sale of the assets of the debtor company
to an buyer or investor is a plan of arrangement involving the
issuance of new shares of the company to the buyer or investor, in
exchange for cash, debt or equity securities of the buyer or
investor, or a combination. The cash and/or debt and equity
securities can then be distributed to the debtor company's
creditors pursuant to the plan of arrangement. From a practical
perspective, the value provided to the creditors must be an
improvement over the recovery that the creditors could reasonably
have achieved through the exercise of their legal rights, such as
the appointment of
a receiver and the liquidation of the debtor company's assets or a bankruptcy. Approval from the debtor company's shareholders is not required ― merely approval from the creditors (unless the court orders otherwise, which might happen in the rare case that the existing equity is thought to still have material value).
Where an acquiror wishes to secure control of a distressed target, there may be instances where CCAA proceedings are not feasible. For example, a great number of Canadian public resource companies are headquartered in Canada but have the bulk of their operations in foreign jurisdictions. CCAA proceedings in Canada may not safeguard the company's operations in the foreign jurisdiction, where obtaining equivalent protection will either be impossible or very time-consuming. If a public issuer requires urgent financing, it can undertake a sizeable private placement that gives an acquiror control of the company while avoiding the usual shareholder approval the TSX normally mandates for significant dilutive financings, on the grounds of financial hardship.
"Stalking Horse Bids"
The CCAA regime allows the purchase of assets by what is known as a "stalking horse bid." This approach is well-known in the United States, but relatively new in Canada. In this process, the debtor company enters into an agreement with a potential bidder, the "stalking horse bidder," for the sale of particular assets or the entire distressed business. An auction or tendering process is then undertaken to obtain the best offer possible. The stalking horse bidder, by virtue of having placed an arm's-length value on the relevant assets through its due diligence, provides a price that underpins the auction process. The stalking horse bidder enters the process knowing it may lose out to a higher bidder and thus negotiates compensation for its transaction costs, usually in the form of a "break fee" that it will receive in the event its bid is not successful. The stalking horse bidder resembles the "white knight" in a takeover situation in that the break fee must be large enough to justify making the bid but small enough not to unduly inhibit the auction process.
Debtor in Possession Financing (DIP)
DIP financing is the provision of new or additional financing to a debtor company seeking to restructure or sell its assets in the context of CCAA protection. Typically, a DIP loan is a secured revolving credit facility. It affords another means by which an investor can gain access to opportunities that might not otherwise be available by conventional methods.
The practice of DIP financing began originally through the exercise of the broad discretion given to the courts under the CCAA. It first appeared as an outgrowth of court-ordered priority charges granted to lenders in order to ensure payment of the administrative and restructuring expenses of the debtor company. Such orders were initially controversial, and some judicial decisions have suggested that if granted at all they should be kept to a bare minimum: only enough to "keep the lights on at the restructuring business."
As a result of amendments to the CCAA that came into effect in 2009, the power of the court to approve DIP financing is now codified. The amended CCAA expressly allows the debtor company to apply for an order to permit a lender to lend new money during a restructuring, potentially on the strength of a so-called "priming charge" that typically ranks ahead of existing secured lenders. The amendments to the CCAA offer general guidance by setting out a non-exhaustive list of factors to be weighed by the court when deciding whether to approve the DIP financing, including any potential prejudice to other creditors (particularly the potential erosion of their secured positions through the priority given to the DIP loan facility).
DIP lending may be attractive to investors for a variety of reasons. If the lender is interested in ultimately acquiring some or all of the debtor's business, providing DIP financing can give the lender a significant and sometimes a pre-eminent role in the management of the debtor company (through covenants in the DIP financing documents) and the course of the restructuring proceedings (as a senior secured creditor). This may be a critical advantage in positioning an investor for an acquisition. Even if the target assets are not purchased, DIP financing can be profitable by virtue of the attractive spread that is often available in such distressed situations, with the risk moderated by a "priming" charge.
The Acid Bath of the Vesting Order
When assets are sold through CCAA proceedings, whether as part of the financing of a restructuring or through a creditor and court-approved overall plan of arrangement, a vesting order is issued by the court. The effect of the vesting order is that the creditors' claims to the assets included in the sale are converted into claims to the proceeds of the sale, with the creditors ranking in their pre-vesting order priorities in respect of the distribution of such proceeds. The assets are transferred free and clear of registered encumbrances, security interests and claims against the assets, unless explicitly assumed by the buyer.
A court order under the CCAA can also remove the need to obtain certain consents and other requirements for closing a transaction. This would include shareholder consent and consents from parties to contracts concerning the assets. For example, the CCAA expressly authorizes the court to assign contracts to an assignee, notwithstanding restrictions on assignment in the contract, if certain pre-conditions are met. In addition, certain regulatory requirements under securities and other legislation can be avoided or ameliorated through the vesting order. Another advantage flowing from court supervision of the process is that the court will expressly approve the transaction, thus reducing the risk of future challenges to the validity of the transaction.
How the CCAA Regime Works
Initial Application to Court
To qualify to use the CCAA, a company must be insolvent and have outstanding liabilities of $5 million or more. To initiate CCAA proceedings, the debtor company must make an application to court for an order imposing a stay of proceedings upon creditors and authorizing the company to prepare a plan of arrangement to compromise its indebtedness with some or all of its creditors.
In support of such application, an affidavit is prepared by the debtor company that describes its background, financial difficulties and the reasons it is seeking CCAA protection. Usually, the initial order is made in the form of a draft order prepared by the debtor company and its advisers, and submitted to the court as one of the application documents, with little to no input from creditors and other stakeholders. Affected parties (including creditors) may apply to court to vary the initial order after it is made.
Generally, an initial order does the following:
- authorizes the debtor company to prepare a plan of arrangement to put to its creditors;
- authorizes the debtor company to stay in possession of its assets and to carry on business in a manner consistent with the preservation of its assets and business;
- appoints a licensed Canada bankruptcy trustee as "monitor", to do as the name suggests ― monitor the business and affairs of the debtor company during the proceedings and the restructuring process;
- prohibits the debtor company from making payments in respect of past debts (other than specific exceptions, such as amounts owing to employees) and imposes a stay of proceedings (i) preventing creditors and suppliers from taking action in respect of debts and payables owing as at the filing date, and (ii) prohibiting the termination of contracts by parties doing business with the company;
- authorizes the debtor company, if necessary, to obtain DIP financing to ensure that it can fund its operations during the proceedings, including setting limits on the aggregate funding and the priority of the security; and
- authorizes the debtor company to disclaim unfavourable contracts, leases and other arrangements, to shut down facilities, and to make provision for the consequences (for example, damage claims) in the plan of arrangement.
The CCAA legislation itself provides that an initial order may only impose a stay of proceedings for a period not exceeding 30 days. The debtor company, however, can ― and often does ― apply for a further order or orders extending the stay of proceedings. Such extensions are generally obtained to permit the stay to continue while the company's plan of arrangement is presented to creditors and approved by the court. The duration of proceedings under the CCAA usually is from 6 to 18 months but can be completed in much less time.
The "Fair and Reasonable" Test
When considering whether to approve a plan of arrangement, the court will consider whether the plan fairly balances the interest of all of the debtor company's creditors, shareholders, employees and other stakeholders and whether the plan represents a fair and reasonable compromise that will permit a viable commercial entity to emerge. The court will also consider factors such as: (i) whether the proposed plan brings more value to creditors than a bankruptcy or liquidation alternative, (ii) whether there has been any oppressive conduct towards creditors, (iii) whether there is the retention of jobs, and (iv) the public interest, in a successful workout strategy. In deciding whether to grant the approval order, the court will also look at the degree of approval of the plan by the debtor company's creditors, noting that the parties involved are generally the best judge of their own interests. The court will generally favour a plan that has received strong support from creditors.
For a plan of arrangement to be approved by creditors, a majority of the creditors representing two-thirds in value of the claims of each class of creditors, present and voting (either in person or by proxy) at the meeting or meetings of creditors, must vote in favour of the plan of arrangement. Considering that such approval is required, and that the CCAA does not contain formal "cram down" provisions, the determination of a "class" of creditors is a key issue in CCAA proceedings.
The CCAA sets out a "commonality of interest" test when determining creditor classes. Aligning the interests and grouping the creditors together properly is often crucial to obtaining creditor approval. In a focused and efficient plan, the right balance needs to be struck between sharing the pain of compromise among creditors fairly, and minimizing complexity, cost and delay.
By taking the time to understand the CCAA regime, those looking to acquire the assets of distressed companies can do so relatively quickly and economically. Not only can assets be successfully acquired on good terms, but reasonable, relatively low risk returns can be obtained by those willing to provide DIP financing to insolvent companies. Significant changes in the economy call for significant changes in business dealings. The CCAA regime will be an important tool in many transactions resulting from the current economic decline.
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