On Friday, February 1, 2013, the Supreme Court of Canada released its highly anticipated decision in Indalex Limited (Re). The ruling stemmed from an appeal of an Ontario Court of Appeal decision that had created commercial uncertainty for financing transactions. The primary issue for lenders was a priority dispute between a court ordered super-priority charge granted to a lender that had provided "debtor-in-possession" (DIP) financing under the Companies' Creditors Arrangement Act (Canada) (CCAA), and deemed trusts under the Ontario Pension Benefits Act (PBA), in respect of wind up deficits in defined benefit pension plans.
The Supreme Court of Canada decision included the following*:
- Unanimous confirmation of the priority of a court ordered charge granted in insolvency proceedings under federal legislation over the interests of provincial pension claims;
- Affirmation of the broad scope of a provincial statutory deemed trust over the full value of a pension wind up deficiency if the defined benefit plan has been wound up prior to the time of determination of the priorities;
- Statements regarding the extent to which courts can harmonize the federal insolvency priority regime under the Bankruptcy and Insolvency Act (Canada) (BIA) and priorities under CCAA proceedings; and
- Elimination in these circumstances of the uncertainty introduced by the Court of Appeal in respect of the applicability of equitable/constructive trust remedies to secured claims.
These issues will be considered further below, followed by some practical implications of the decision.
Indalex had obtained creditor protection under the CCAA. In the CCAA proceedings, beneficiaries of two underfunded defined benefit pension plans, sponsored and administered by Indalex opposed a motion to distribute the proceeds from the sale of the company's assets to satisfy a secured claim. The secured claim was a court ordered super-priority charge granted in connection with DIP financing provided to Indalex. It is important to note that in Indalex, there were no secured pre-filing claims in competition with the pension deficiency claim and no bankruptcy proceedings had been initiated by the secured DIP creditors.
The beneficiaries argued that assets of Indalex with value equal to the full funding deficiencies (not just unpaid amounts due to be paid) were deemed to be held in trust pursuant to provisions of the PBA and equivalent proceeds of sale should be remitted to the plans on a priority basis, regardless of the court ordered super-priority of the secured claim. The beneficiaries also argued that there were governance, fiduciary duty and notice issues inherent in Indalex's CCAA process, and the treatment of pension interests therein, that justified the imposition of the equitable remedy of a constructive trust in priority to the secured claim. The CCAA court nevertheless approved the distribution to satisfy the secured DIP claim.
The Ontario Court of Appeal overturned the CCAA court's decision and found that where a pension plan is wound up the deemed trust provisions of the PBA apply to all amounts required to liquidate pension plan wind up liabilities, even if those amounts are not yet due under the plan or the regulations. The Court of Appeal held that the deemed trust amount should be paid in priority to the holder of a super-priority DIP charge over the assets of Indalex, despite the CCAA court order creating the charge specifying that it ranked in priority over trusts "statutory or otherwise". The Court of Appeal also found that Indalex had breached its fiduciary obligations in the course of acting as administrator of the plans (in part through steps taken within the CCAA proceedings). Based on this finding, the Court imposed a constructive trust over Indalex's assets with respect to the wind up deficiencies in the plans, a constructive trust that was senior to the super-priority DIP charge.
Priority of the Court Ordered Super-Priority DIP Charge
The Supreme Court of Canada unanimously confirmed the ability of a Court exercising authority under the CCAA to order a super-priority charge for a DIP loan to prime an interest protected by a statutory deemed trust under provincial legislation such as the PBA. This decision was based upon the doctrine of paramountcy which resolves conflicts between the application of valid and overlapping provincial and federal legislation in insolvency matters in favour of the federal provision.
The Court's reasons specifically referred to the order of the CCAA court that the DIP charge ranked in priority to "all other security interests, trusts, liens, charges and encumbrances, statutory or otherwise." Since it was impossible to comply with both the priority of the PBA deemed trust and that of the DIP charge, the Court held that the DIP charge issued under the federal CCAA was paramount and superseded the provincial deemed trust.
The Scope of the Deemed Trust
A majority of the Court affirmed the expansion of the scope of the provincial statutory deemed trust in the PBA in respect of a pension plan being wound up to include the entire wind up deficiency of the pension plan, even if those amounts are not yet due under the plan or the regulations. In Justice Deschamps' reasons, this finding was based upon statutory interpretation, the broadening scope of the deemed trust protection in the legislative history of the PBA and the remedial purpose of the PBA deemed trust provisions - to protect the interests of plan members.
Application of the BIA Priority Regime in CCAA Proceedings
As noted, Indalex did not involve the consideration of pre-filing secured creditors' rights, there was no bankruptcy process and the issues related only to provincially registered (as opposed to federally registered) defined benefit pension plans. There were, however, some brief comments made by the Supreme Court regarding whether federal paramountcy would apply in any CCAA proceedings if no bankruptcy orders were issued. The effect of these comments, which did not form part of the rationale for the priority judgment, may impact recent judgments, including of the Supreme Court, intended to curtail 'statute shopping' and apply a harmonized interpretation to Canada's two primary insolvency statutes (the CCAA and BIA), particularly in respect of priority entitlements.
No Constructive Trust Imposed
The majority of the Court determined that while Indalex had breached its fiduciary duty as plan administrator, a constructive trust in respect of the plan deficiency was not an appropriate remedy in this case. The application of a constructive trust had been a particularly troubling issue arising from the Court of Appeal decision for financers who generally require a level of predictability of outcome on matters such as priority.
Some Practical Implications
Following the somewhat unexpected findings of the Ontario Court of Appeal in April of 2011, lenders to businesses with defined benefit pension plans in Ontario often took additional protective measures. These measures included greater due diligence in respect of defined benefit plans, stricter contractual terms in respect of such plans and, in some areas such as asset-based lending, reserving up to 100% of any plan funding deficiency against the availability under the applicable credit facilities. In other cases, access to credit may have been restricted due to uncertainty regarding these issues, including for companies seeking DIP financing in the context of CCAA proceedings.
While the brief, obiter comments noted above may raise concern about the automatic subordination of the pension deficiency deemed trust in any CCAA proceedings, the Court in Indalex did not deal expressly with the ability of a secured creditor to bring a motion to initiate bankruptcy proceedings following a failed attempt to restructure or complete a liquidation under the CCAA – a common and successful tactic used in insolvencies with court approval by secured creditors looking to 'reverse the priorities.' Rather, the Court addressed whether a motion brought by the debtor, Indalex, to permit an assignment in bankruptcy (in part for the purpose of reversing priorities) amounted to a breach of fiduciary duty by Indalex in respect of the plan beneficiaries. As a result, it is likely that prior case law permitting a secured creditor to pursue a motion to lift a CCAA stay and petition a debtor into bankruptcy to reverse priorities is still effective.
With the removal of the equitable remedies aspect of the case, we believe asset-based lenders (ABL lenders) will feel much more comfortable in financing companies with provincially registered (as opposed to federally registered) defined benefit plans in a deficiency position and will not automatically reserve from availability all such deficits. Instead, we expect that ABL lenders will consider whatever uncertainties remain on a case-by-case basis. Those considerations will certainly include a greater likelihood that full cash dominion will be required, and will be required to be continued during any restructuring attempt, in order to ensure that past advances (which cannot be prioritized by a court order in the same manner as DIP advances) will be repaid and all disbursements during the restructuring will enjoy the protection of the DIP order similar to the one included in the Indalex case.
We also expect that lenders will continue to include similar representations, warranties and covenants (including default triggers and prohibitions on wind ups and creating new defined benefit plans) and to take federal Bank Act security wherever possible, as they have been doing prior to the Supreme Court decision.
It is early days yet but, in an insolvency context, we foresee an increased frequency of 'pre-packaged' restructuring plans framed under BIA proposal proceedings at the insistence of the lenders and parties offering interim financing in insolvency cases because the default for a failed restructuring attempt is bankruptcy (and the relatively high likelihood of BIA priorities applying), not a contested lift of stay motion within a CCAA to permit a bankruptcy to ensue to bring BIA priorities into play.
* While perhaps not a direct issue for lenders, the Supreme Court decision gave rise to some uncertainty regarding the relevant time when a plan must be wound up in order for the PBA deemed trust to apply in the context of CCAA proceedings. The Court was unanimous in concluding that the PBA deemed trust for wind-up deficiencies did not apply to the one Indalex pension plan that had not been wound up at the relevant time. However, in our view, uncertainty remains regarding the determination of what is the relevant time when a plan must be wound up in order for the PBA deemed trust to apply in the context of CCAA proceedings and what restrictions may exist on a pension regulator ordering a plan wind-up after CCAA proceeding have commenced. Since the timing of plan wind up can impact the scale of any plan deficiency and the priority of payments in respect of that deficiency, we anticipate further debates in CCAA proceedings in cases where a pension regulator is seeking to order a plan wind up until these issues are clarified.
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