Canada: Indalex Decision: Insolvency Law v. Pension Law, Round Three

The Supreme Court of Canada's decision in the case of Re Indalex Ltd. [2013] SCC 6 (the "Decision") does not, as one national newspaper put it place "creditors before pensioners". The Decision which overturned the Ontario Court of Appeal's decision in Re Indalex Ltd. [2011] O.J. No. 1621 ("Indalex") reinforces the constitutional doctrine of paramountcy, which is the legal principle that federal law regarding priority of creditors in bankruptcy and insolvency prevail over other priority rights that may be created by provincial law, such as creating a deemed trust in favour of members of a pension plan. A number of Provinces have deemed trust provisions in their pension benefits legislation. By example, in Ontario the legislation provides that where a pension plan is wound up, the employer is deemed to hold in trust for the beneficiaries of its pension plan an amount equal to the employer contributions accrued to the date of the wind-up but not yet due under the pension plan or the regulations to the Pension Benefits Act.

The Decision confirms that where an employer in a single employer defined benefit pension plan takes on and continues to hold the dual roles of both the "administrator" and the "employer" of that pension plan, the employer has and retains fiduciary obligations to the pension plan members. The scope of that fiduciary duty divided the members of the Supreme Court of Canada, resulting in three different views on how that duty should be discharged.

Eight Things Employers Need to Know about the Decision

1. The Supreme Court has not changed pension law.

The Supreme Court recognizes that the legislature (in this case the Ontario Legislative Assembly) can and should set out what is intended for the obligations of an employer on the winding up of a pension plan and to what extent the deemed trust legislative provision affects those obligations. The Supreme Court was clear that because the Executive Plan had not been wound up, the legislation did not provide for a deemed trust for contributions in the future (that is, before wind-up commences). Three of the Justices examined in detail the legislative history of the deemed trust provisions of the Ontario Pension Benefits Act. The Justices noted that in 1983 the Minister told the Ontario legislature that the statutory deemed trust under the Act was not intended to include the future potential liability of an employer on wind-up of a pension plan [paragraph 168 of the Decision];

2. In an insolvency, federal legislation such as the CCAA will prevail over provincial legislation to the extent there is a conflict where the priority of creditors is concerned, including creditors who are members of a pension plan.

All seven Justices agree on that point. It is up to Parliament to decide whether changes should be made to the Bankruptcy and Insolvency Act or to the CCAA to address this issue;

3. Pension legislation can and does differ from province to province on this and other issues.

By way of example, the provinces of Ontario and Alberta have similar provisions on the creation of the deemed trust for pension plan contributions, but the legislation of each Province is not as similar on other aspects of what is the deemed trust obligation of an employer. That was a crucial point in the Indalex decision as between the Salaried Pension Plan and the Executive Pension Plan;

4. Pension law and insolvency law can be difficult to rationalize.

In Indalex, the Ontario Superior Court of Justice ruled in favour of super-priority for DIP lenders, the Ontario Court of Appeal (with a Justice on that Court with substantial pension law experience), ruled in favour of the priority of the pension plans, and the Supreme Court was unanimous on the priority issue of the Appeal, but divided on what should be the remedy for the breach of fiduciary duty by Indalex;

5. In an insolvency, the interest of the lenders can trump the interest of other parties, like pension plan members.

The Supreme Court noted that the "harsh reality" is that lending to an insolvent entity is governed by the "commercial imperatives of the lenders [and] not by the interest of the plan members or the policy considerations that lead provincial governments to legislate in favour of pension fund beneficiaries" [paragraph 59 of the Decision].

6. An employer which is the administrator of its pension plan has a fiduciary duty to the pension plan members and that duty does not end if the employer becomes insolvent.

The Supreme Court unanimously found that Indalex had a fiduciary duty to the pension plan members, even when Indalex was insolvent and seeking to restructure. The Supreme Court found a conflict of interest will exist where the employer has the dual responsibility of being both employer and administrator of the pension plans. How that fiduciary duty is to be satisfied in a case like that of Indalex, varies. This is demonstrated in how the Court should recognize the interest of the pension plan members. Three Justices of the Supreme Court asserted that the Judge hearing the application to approve the DIP financing and the priorities for the DIP lenders, should have been advised of Indalex's fiduciary duty to the pension plan members, so that the pension plan members could have "the opportunity to present their arguments" [paragraph 73 of the Decision]. Four of the Justices of the Supreme Court went further and asserted that the role of administrator should have been given at that time to an independent person.

7. Independent representation is needed for pension plan members in an insolvency.

Employers that retain the dual responsibility of the Employer and the Pension Plan Administrator, when applying for protection under the CCAA, and indeed DIP lenders and their advisors as well, will need to take into account that four of the seven Justices of the Supreme Court, to one extent or another, noted the need for the Court hearing the initial application under the CCAA to not only be made aware of, but to assess whether an independent Administrator or an independent lawyer is needed for the pension plan members, and whether there ought to be limits on the DIP facility (and presumably its priority) until pension plan members can be represented by legal counsel [paragraph 216 of the Decision]; and

8. A breach of fiduciary duty by an employer to the pension plan members may result in a constructive trust for the pension plan members on the assets of the employer.

Two of the Justices of the Supreme Court agreed with the Ontario Court of Appeal that the seriousness of the breach by Indalex of its obligations to the pension plan beneficiaries justified the Court of Appeal to impose a constructive trust on the proceeds of the eventual sale of the Indalex assets. If there had been enough proceeds of the sale of the Indalex assets to pay the DIP lender, and if the Supreme Court had upheld the constructive trust, would the constructive trust then have had priority over other secured lenders to Indalex? That may be an issue of concern to secured lenders to employers with a pension plan.

Background on Supreme Court of Canada's Indalex Decision

Briefly, Indalex was the sponsor of two registered defined benefit pension plans, known as the Executive Plan and the Salaried Plan. Indalex took on and retained the dual role of being both the employer and what pension law calls the "Administrator" of the pension plans. Indalex sought protection from creditors under the Companies' Creditors Arrangement Act (the "CCAA"). At the time that Indalex sought protection under the CCAA, the Salaried Plan was in the process of being wound up, but the Executive Plan had not started its winding up process. Both plans had wind-up deficiencies.

During a series of applications to the Ontario Superior Court of Justice heard by a Judge who is very experienced in re-organization and insolvency law, the Court authorized Indalex to enter into debtorin-possession ("DIP") financing in order to allow Indalex to operate during its proposed reorganization. DIP financing allows a corporation in financial difficulty to raise funds on a super-priority secured basis, provided that the Court in the CCAA proceedings has approved that financing. The Court granted to the DIP lenders super-priority for the DIP financing over the claims of all other creditors of Indalex. Ultimately, and with the approval of the Court, Indalex sold its business, but the purchaser did not assume the wind up liabilities of the two pension plans, and proceeds of sale were not sufficient to pay back the DIP lenders. The Court then ordered an amount to be held back from the sale proceeds until the Executive and Salaried pension plan members could make their case whether the proceeds of sale should be used to pay the wind-up deficits in the pension plans.

The plan members argued that a deemed statutory trust under the Pension Benefits Act of Ontario gave priority to the wind-up deficiencies in the two pension plans over the court-mandated super-priority of the DIP loan. Additionally, the pension plan members claimed a "constructive trust" over the sale proceeds, which the pension plan members asserted arose from the breach of fiduciary duty of Indalex as the "Administrator" of the pension plans.

The Judge held that the deemed trust provisions in the Pension Benefits Act did not apply to wind-up deficiencies and that the plan members were unsecured creditors of Indalex. The Judge gave the DIP lenders priority over the pension plan claims. The Ontario Court of Appeal reversed that ruling, and held that pension plan wind-up deficits are subject to a deemed trust under the Pension Benefits Act, and as well to a constructive trust by virtue of a breach of fiduciary duty by Indalex. The Court of Appeal held that those trusts resulted in the pension plan deficiency having priority over the DIP lenders, and all other secured creditors of Indalex.

The appeal to the Supreme Court of Canada included not only the lawyers acting for the DIP lenders and the pension plan members, but also included as intervenors: the Superintendent of Financial Services of Ontario, the Insolvency Institute of Canada, the Canadian Labour Congress, the Canadian Federation of Pensioners, the Canadian Association of Insolvency and Restructuring Professionals, and the Canadian Bankers Association, thereby reflecting the importance of this issue to both insolvency and pension law.

Does Provincial Pension Legislation or Federal Insolvency Legislation Prevail?

The appeal was heard by seven Justices of the Supreme Court of Canada. The Court examined four issues. Three of those issues are discussed here. (The fourth issue related to costs and is beyond the scope of this paper).

1.  Extent of the deemed trust provisions.

The first issue was whether the statutory deemed trust for contributions to a pension plan which is provided for in section 57(4) of the Pension Benefits Act extends to the wind-up deficiency payments required when a pension plan is wound up. The Supreme Court took note that the situation was different for the Executive Plan, as it had not commenced to wind-up. Four of the seven Justices of the Supreme Court agreed firstly that the wind-up deficiency payments due to a pension plan are included within the deemed statutory trust in the Act, and secondly agreed that the time of the calculation of the wind-up contributions required to the pension plans is not relevant to that determination as long as the liabilities are assessed as of the date of the wind-up. Those four Justices agreed with the Ontario Court of Appeal that Indalex was deemed to hold in trust the money necessary to satisfy the wind-up deficits of the Salaried Plan but not the Executive Plan, as the deemed trust had not come into existence as the Executive Plan had not begun to be wound up at the date when the Order was granted to give Indalex protection under the CCAA. Three of the Justices of the Supreme Court came to a different conclusion on this first issue, and by examining the legislative history of the deemed trust provisions of section 57 of the Pension Benefits Act, concluded that there was never an intention on the part of the Ontario Legislature to provide a deemed trust for future liabilities of an employer that arise if a pension plan is wound up. Rather, those three Justices concluded that the legislative intent is to exclude from the deemed trust provision those liabilities that arise only upon a wind-up. Except for the second issue that the Supreme Court examined, the deemed trust provision contained in section 57 of the Pension Benefits Act would have covered the wind-up liabilities of the Salaried Plan.

2. Does a provincial deemed trust apply in federal CCAA proceedings?

The second issue, and what turned out to be the issue that formed the Decision, was whether the statutory deemed trust under the Pension Benefits Act, which is created by provincial legislation, continues to apply in CCAA proceedings, which is federal legislation like the Bankruptcy and Insolvency Act. All seven of the Justices of the Supreme Court held that CCAA proceedings and the CCAA legislation governs because of the legal doctrine of paramountcy: which is, when in conflict, federal legislation will prevail over provincial legislation. Because the CCAA and the Pension Benefits Act of Ontario were in conflict with respect to creditor priority rights, the federal CCAA prevailed. Thus the DIP lenders had priority, and since there were insufficient monies from the sale of the assets of Indalex to satisfy the loans made by the DIP lenders, there were no monies left for any other creditors, including the pension plan members.

3. Does a breach of a fiduciary obligation by an employer create a "constructive trust" in favor of the pension plan members in priority to other creditors?

The third issue relating to pension law, and to a lesser extent insolvency law, is whether, as the Ontario Court of Appeal found, the breach by Indalex of its fiduciary duties to the pension plan members was such that a constructive trust should be found by the Court which would have resulted in payment to the pension plans of the amount of the purchase price which the Ontario Superior Court ordered to be held back while the priority dispute between the pension plans and the DIP lenders was determined. All seven Justices found that Indalex breached its fiduciary duty to the plan members in the course of the CCAA proceedings. The existence of the conflict of interest between Indalex's duties as the Administrator of the pension plans and its duties to other stakeholders in Indalex, such as its shareholders, did not by itself constitute the breach by Indalex of its fiduciary duty. However the failure of Indalex to take the necessary steps to deal with that conflict of interest was the breach. As the Summary of the Supreme Court's decision puts it "in short, the difficulty was not the existence of the conflict, but the failure to address it." How that failure should be addressed, and what the remedy should be, was not resolved by the Supreme Court.

What Now?

The Supreme Court's Decision reinforces the doctrine of paramountcy: where provincial legislation, including, but not limited to pension benefits legislation, creates different priorities than that under federal insolvency legislation, federal legislation prevails.

An employer which acts as both the plan sponsor and the administrator of a pension plan, and particularly for a defined benefit pension plan, will need to carefully assess whether it should assign its obligation as the Administrator of the pension plan to an independent party, prior to, or at the time of, seeking protection under the CCAA.

Lenders to such an insolvent employer may, or will, want to reduce the risk of a constructive trust being applied to the eventual sale proceeds of the employer's assets, as the Ontario Court of Appeal and two of the seven Supreme Court Justices determined. That risk can be reduced by having the employer cease to be the Administrator, or arranging for legal counsel for the pension plan members, or both. Interestingly, one group of Justices of the Supreme Court that would have found a constructive trust and another group of Justices that did not find a constructive trust, both refer to the same earlier decision of the Supreme Court of Canada (Souris) as support for each coming to a different conclusion on whether a constructive trust on the employer's assets may exist for pension plan wind-up deficiencies where the employer has breached its fiduciary duty to the pension plan members.

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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