On February 1, 2013, the Supreme Court of Canada (SCC) released its decision in Sun Indalex Finance, LLC v. United Steelworkers (Re Indalex). With respect to one critical issue, the SCC confirmed that a court-ordered debtor-in-possession (DIP) charge had priority over a deemed trust (akin to a statutory security interest) securing the debtor's obligation to fund a pension wind-up deficiency on the wind-up of a defined benefit (DB) pension plan. However, the DIP charge priority issue was only one of four critical issues considered by the SCC.
The SCC made the following key findings:
- Scope of the Deemed Trust. By way of a four-to-three majority, the SCC held that the deemed trust created by the Pension Benefits Act (Ontario) (PBA) extends to the obligation of a pension plan sponsor to fund the pension wind-up deficiency on the wind-up of a DB pension plan. The deemed trust does not arise unless and until the pension plan is wound up. Outside of a bankruptcy – a liquidation proceeding under the Bankruptcy and Insolvency Act (Canada) (BIA) – the Personal Property Security Act (Ontario) (PPSA) provides that the deemed trust has priority over a security interest granted by the debtor company in inventory and receivables. The deemed trust also takes priority over unsecured debt, again outside of a bankruptcy.
- Priority of DIP Charge. All seven justices held that a court supervising a proceeding under the Companies' Creditors Arrangement Act (CCAA) has authority to grant a DIP charge that has priority over the deemed trust created by the PBA. The SCC concluded that to the extent valid orders issued under the federal CCAA conflict with the provisions of the provincial PBA and PPSA, the orders under the federal legislation take precedence as a result of the doctrine of federal paramountcy.
- Scope of Fiduciary Duty. All seven justices held that where there is a conflict of interest between the debtor's corporate role and its role as pension plan administrator, the conflict must be addressed so as to avoid a breach of its fiduciary duty to the pension plan beneficiaries. The SCC held that Indalex breached its fiduciary duty to the pension beneficiaries primarily because the beneficiaries were not given notice prior to Indalex seeking the DIP charge in priority to their claims.
- Constructive Trust. By way of a five-to-two majority, the SCC held that the imposition of a constructive trust, granting the pension beneficiaries priority over the DIP charge as against the assets of Indalex, was not an appropriate remedy for Indalex's breach of fiduciary duty in the circumstances. That is, there was no specific asset that was inappropriately acquired by Indalex because of its breach.
In its 160-page decision, the SCC analyzed a host of complex and interconnected issues dealing with principles of statutory interpretation, principles of constitutional law and public policy. This bulletin focuses on explaining the central conclusions reached by the SCC and the practical implications of those conclusions for commercial lenders, debtor companies and insolvency professionals.
In April 2009, Indalex Limited (Indalex) and certain related entities sought and obtained protection, pursuant to the CCAA, from the Ontario Superior Court of Justice [Commercial List] (the CCAA Court). Other than notice to the existing lender, the CCAA application was made without notice to other stakeholders. Indalex's parent company (Indalex U.S.) and its related U.S. entities also sought protection pursuant to Chapter 11 of the U.S. Bankruptcy Code, on an urgent basis. Shortly after filing for CCAA protection, Indalex sought and obtained DIP financing, secured by a superpriority DIP charge, ranking in priority to all liens and encumbrances including deemed trusts.
At the time of filing, Indalex was the corporate sponsor and plan administrator of two registered DB pension plans commonly known as the "Salaried Plan" and the "Executive Plan". Both the Salaried Plan and Executive Plan were in an underfunded position. At the time of filing, the Salaried Plan was in the process of being wound up. Although the union representing certain pension plan beneficiaries was provided with short notice, pension plan beneficiaries were not given direct notice of Indalex's motion seeking the granting of the DIP charge.
The issue initially brought before the CCAA Court can be stated succinctly:Indalex had an obligation to repay its DIP financing from the proceeds generated from the sale of its assets in the CCAA proceeding. It also had an obligation to fund the wind-up deficiencies in its pension plans in accordance with the provisions of the PBA. It had insufficient proceeds to do both. The question before the CCAA Court was which obligation had priority. The CCAA Court concluded that the DIP charge had priority. The Court of Appeal for Ontario reversed that finding. The matter was ultimately resolved by the SCC, which held that the DIP charge had priority.
Scope of the Deemed Trust
The threshold issue decided by the SCC was whether the statutory
deemed trust provided for in the PBA secured the obligation to fund
the wind-up deficiency of a DB pension plan. If it did not, the
claims of the pension beneficiaries for the wind-up deficiency
would be unsecured claims, subordinate to the DIP charge.
Deschamps J., writing for the majority on this point, agreed with the Court of Appeal and concluded that the PBA deemed trust secured the obligation to fully fund the wind-up deficiency on the wind-up of a DB pension plan. As a result of the application of s.30(7) of the PPSA, in Ontario, the deemed trust has priority over security interests over inventory and receivables and their proceeds. If the pension plan was not wound up, however, no deemed trust could arise.
In a strong dissent on this point, Cromwell J. (with whom McLachlin C.J. and Rothstein J. concurred) concluded that the deemed trust did not extend to the obligation to fund the wind-up deficiency. Cromwell J. went on to note the policy concerns that arise as a result of extending the deemed trust to secure the wind-up deficiency:
"A deemed trust of that nature might give rise to considerable uncertainty on the part of other creditors and potential lenders. This uncertainty might not only complicate creditors' rights, but it might also affect the availability of funds from lenders. The wind-up liability is potentially large and, while the business is ongoing, the extent of the liability is unknown and unknowable for up to five years. Its amount may, as the facts of this case disclose, fluctuate dramatically during this time. A liability of this nature could make it very difficult to assess the creditworthiness of a borrower and make an appropriate apportionment of payment among creditors extremely difficult."
Notwithstanding the strong dissent of three of the SCC judges, the remaining four SCC judges affirmed the Court of Appeal's judgment that in Ontario the deemed trust securing the wind-up deficiency of a DB pension plan has priority over the claims of secured creditors in inventory and receivables. The deemed trust also has priority over unsecured creditors.
Priority of DIP Charge
The Court of Appeal for Ontario had found that although the CCAA Court had the power to grant a DIP charge that would supersede the deemed trust, the DIP charge in Re Indalex did not have that effect because the doctrine of federal paramountcy was not "invoked". In short, the doctrine of federal paramountcy provides that where validly enacted federal law conflicts with validly enacted provincial law, or where complying with provincial law would frustrate the purpose of the federal law, the federal law governs.
Deschamps J., writing for the majority on this point, held that the Court of Appeal erred in finding that paramountcy had to be invoked at the time the DIP charge was granted in order for the DIP charge to "prime" the deemed trust. Deschamps J. noted that the CCAA Court made specific findings of fact that, if the DIP charge was not granted, a going concern solution to the business would not be achievable. Therefore, there was a finding, in substance by the CCAA Court, that giving effect to the priority created by the PBA would frustrate the purposes of the CCAA, even though paramountcy was not expressly invoked and the PBA deemed trust was not referenced. Deschamps J. rejected the notion put forth by the Court of Appeal that the purposes of the CCAA would not have been frustrated because the DIP lenders would still have provided the DIP financing even if the DIP charge ranked junior to the PBA deemed trust. Deschamps J. noted that granting priority for the DIP charge is a key aspect of the debtor's ability to attempt a workout.
The majority of the SCC, by way of concurring reasons of
Deschamps J. and Cromwell J., held that where a conflict arises
between a company's corporate interests and its fiduciary
obligations as a pension plan administrator, the company has an
obligation to address that conflict in order to avoid a breach of
fiduciary duty. In this case, it was held that Indalex ought to
have addressed the conflict that had arisen between its two roles,
by providing an opportunity to the pension beneficiaries to have
their interests meaningfully represented. The majority disagreed
with the Court of Appeal's conclusion that the very act of
seeking relief under the CCAA without notice to the pension plan
beneficiaries was a breach of fiduciary duty.
Cromwell J. went on to note that Indalex did not breach its fiduciary duty by seeking the relief that it did in the CCAA case, which relief included seeking approval of the sale of its assets and seeking authority to assign itself into bankruptcy (the deemed trust is not operative in bankruptcy). Cromwell J. then sought to provide guidance on how to address the conflict of interest that arises when an employer, subject to CCAA proceedings, is also the pension plan administrator:the employer-administrator which finds itself in a conflict of interest must bring that conflict of interest to the attention of the CCAA judge; the judge may then seek to address that conflict by appointing an independent administrator or independent representative counsel on terms appropriate in the case; a judge may also find it feasible to give notice directly to pension beneficiaries or, alternatively, recognizing that this may not always be feasible, the judge could authorize limited draws on the DIP facility until notice can be given to the beneficiaries. In that regard, Cromwell J. noted that CCAA courts have limited their initial orders to the issues that need to be resolved immediately and have left other issues to be resolved after all interested parties have been given notice.
Cromwell J., again speaking for the majority, held that a remedial constructive trust for a breach of fiduciary duty is only appropriate if the wrongdoer's acts give rise to an identifiable asset which it would be unjust for the wrongdoer (or sometimes a third party) to retain. Indalex's breach – the failure to meaningfully address the conflicts of interest that arose during the CCAA process – had no adverse impact on the plan beneficiaries in the sale approval which gave rise to the asset in question (i.e., the remaining proceeds of sale). Indeed, the interests of the plan beneficiaries were fully represented and carefully considered before the sale was approved. Imposing an equitable remedy that gave the pension plan beneficiaries full recovery of their claims, at the expense of another creditor constituency, was unreasonable in the circumstances. Cromwell J. crystallized the point in the following way:
"A judicially ordered constructive trust, imposed long after the fact, is a remedy that tends to destabilize the certainty which is essential for commercial affairs and which is particularly important in financing a workout for an insolvent corporation."
In concurring reasons, Deschamps J. noted that the pension beneficiaries also sought priority over the DIP charge on the basis of equitable subordination. The basis for claims of equitable subordination is usually that the secured lender has engaged in inequitable conduct and thus the court should exercise its discretion to subordinate the secured lender's claims. Deschamps J. noted that the doctrine of equitable subordination has not been endorsed in Canada and she did not intend to endorse it in this case. Deschamps J. went on to note that, in any event, there was no evidence in this case that the lender had engaged in inequitable conduct.
Implications for Commercial Lenders and Debtor Companies
The SCC's decision in Indalex is a mixed result for commercial lenders and debtor companies with underfunded DB pension plans that need secure and stable access to commercial capital.
Depending on the extent of the estimated wind-up deficiency, a debtor's access to financing outside a DIP context may be severely constrained or even eliminated. Even if the risk of the priority deemed trust is manageable, lenders may still require credit enhancements, increased financial diligence, greater and more frequent reporting requirements and pension plan actuarial valuations, a host of more restrictive covenants in credit agreements, the taking of additional reserves against loan advances and/or increased pricing to reflect the greater risk associated with lending to companies with large unfunded pension wind-up deficiencies.
The deemed trust priority is not operative in a BIA liquidation, as noted above. Therefore lenders may consider their ability, upon a default, to seek to have the debtor adjudged bankrupt. The SCC held that it is not a breach of fiduciary duty for a debtor that is also a pension plan administrator to bring a motion in a CCAA case to seek authority to assign itself into bankruptcy, as long as the conflict is addressed, primarily by providing an opportunity for the pension beneficiaries to have their interests meaningfully represented. It did not, however, comment on a debtor's ability to voluntarily assign itself into bankruptcy outside of a CCAA case, where no court permission is required.
Unfortunately, the Indalex decision has resulted in material risks for commercial lenders (whether secured or unsecured) to debtors with underfunded DB pension plans as well as governance challenges for sponsors/administrators of pension plans. How these risks can be managed remains to be seen. On the other hand, the SCC did provide needed certainty which will facilitate DIP financing in Canada. The SCC concluded that the court-ordered DIP charge had priority over the PBA deemed trust. As stated recently by the Ontario Court in Re Timminco, no commercially motivated lender could be expected to advance funds without the priority afforded by the DIP charge. The SCC recognized this reality and, in doing so, supported the stability, certainty and predictability that are vital for the financing of a successful CCAA restructuring.
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.