Two recent Ontario court decisions have clarified the basis upon
which underwriters faced with litigation claims can claim indemnity
compensation from insolvent issuers. The decisions weaken the
strength of underwriters' claims in certain circumstances and
may have implications for underwriters in structuring indemnity
provisions and in responding to civil litigation, particularly
class action proceedings.
In March 2012, in response to criminal and regulatory
investigations and class action proceedings alleging
misrepresentations in its public filings, Sino-Forest Corporation
sought protection from its creditors by entering into insolvency
proceedings under the Companies' Creditors Arrangement Act
(CCAA). In response to the CCAA proceedings, Sino-Forest's
underwriters (as well as other third parties including the
company's auditors) filed CCAA claims for compensation from
Sino-Forest stemming from their costs and liability in regard to
the class actions filed against them.
The underwriters' claims were based on the contractual
indemnity provisions in the underwriting agreements between the
underwriters and Sino-Forest. The underwriters argued that, for the
purposes of the CCAA, their claims for indemnity ranked as
"creditor" claims. Sino-Forest's other creditors
contested this view and argued that the underwriters' claims
were lower-ranking "equity" claims. Given that
Sino-Forest's assets were not sufficient to satisfy the claims
against it, the determination of whether underwriters' claims
ranked as "creditor" or "equity" claims would
likely determine whether the underwriters would be able to recover
any compensation from Sino-Forest in regard to the class
The Ontario Superior Court of Justice held that the indemnity
claims made by the underwriters largely ranked as
"equity" claims, a finding that was upheld by the Ontario
Court of Appeal.
The courts reasoned that the characterization of an indemnity
claim under the CCAA turns on the character or "nature"
of the underlying primary claim. Since the underwriters'
indemnity claims were based on underlying class action claims
brought against the underwriters by equity claimants
(Sino-Forest's shareholders), the indemnity claims made by the
underwriters in response to those civil actions were found to also
be properly considered as "equity" claims. As a practical
result, the underwriters' indemnities from Sino-Forest were of
little or no value, since "equity" claims rank behind
"creditor" claims in a CCAA proceeding.
IMPLICATIONS FOR UNDERWRITERS
There are several implications of the decisions. The
"nature" based reasoning used by the courts suggests that
not all offerings will be treated equally in terms of indemnity
protection. In particular, underwriters of debt securities of
issuers that become insolvent could have their indemnity claims be
considered as "creditor" claims because the nature of the
underlying litigation claim against the underwriter for such
offerings would be based on claims by creditors, not shareholders.
On the other hand, underwriters of equity securities will likely
have their indemnity claims treated as "equity" claims
ranking behind creditor claims. The reasoning of the decisions
suggests that insofar as the "nature" of an indemnity
claim can be separated from an underlying liability to
shareholders, it may constitute a higher-ranking
"creditor" claim. In light of the decisions, underwriters
will want to be mindful that indemnity provisions they agree to are
broad enough to encompass not only costs stemming from an
underlying liability to shareholders, but also potentially
higher-ranking "creditor" claims for other expenses, such
as legal costs expended in denying a claim by shareholders.
The "nature" based classification of indemnity claims
could also have implications for litigation strategy in some cases,
as it could weigh in favour of completely denying liability and
defending a claim (thus incurring more legal costs that are
potentially "creditor" claims) to attempt to reduce or
avoid a liability payout to the claimants (which would likely rank
as a lower-ranked "equity" claim and attract no
compensation from an insolvent issuer). Similarly, in negotiating a
settlement to a class action where the issuer is insolvent and the
underwriter has made indemnity claims, underwriters will want to
consider the implications of any settlement on their indemnity
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