Article by I. Berl Nadler and Karine De Champlain
The two principal Canadian restructuring statutes are the Bankruptcy and Insolvency Act1 (the "BIA") and the Companies’ Creditors Arrangement Act2 (the "CCAA"). The CCAA, which will be the focus of this article, was originally enacted by Parliament in 1932- 33 in the midst of the Great Depression, with the intention of providing an alternative to the liquidation of companies in financial difficulty and providing a structured environment for the negotiation of compromises between a company and its creditors.
The CCAA fell into significant disuse between the years of the Great Depression and the 1980s when it was revived for use in a modern setting. One of the challenges presented in the adaptation of the CCAA for modern purposes was the absence of any express provisions therein for the financing of restructuring expenses. Accordingly, applicants who filed under the CCAA found it necessary to set aside significant "war chests" or to spend considerable amounts of time at the outset of the proceedings to obtain court approval for the use of otherwise generally unencumbered assets in order to finance ongoing operations during the stay period.
These restructuring expenses generally include, but are not limited to, (a) the costs of operating the business as a going concern during the course of the proceeding; (b) the fees and disbursements of the monitor appointed by the court to oversee the restructuring process, including the legal fees of the monitor’s counsel; and (c) the fees and expenses of the company’s own legal counsel and any restructuring professionals appointed or retained by the company to assist it in restructuring its operations and formulating a plan of compromise or arrangement.
Under ideal conditions, a CCAA applicant would have sufficient cash flow from operations to satisfy its funding requirements during the restructuring, rendering further borrowings unnecessary. More typically, however, the applicant will require access to a new source of funding to complete its restructuring successfully. A lender providing such debtor-in-possession (or "DIP") financing is unlikely to do so without some assurance that advances made to the debtor company in the interim period will be adequately secured.
In some cases, the debtor has unencumbered assets that can be charged as security for the funds advanced. One early example of this type of funding was sanctioned by the so-called "GAR" Order initially obtained by the Olympia & York group of companies ("O&Y") in the context of the CCAA proceedings involving O&Y. 3 In that case, a number of creditors who held security over specific assets had brought motions before the court seeking to segregate revenues in order to ensure that the rents from buildings owned by a specific debtor company would not be used to pay the expenses of another building owned by another debtor. Such a segregation was generally inconsistent with the centralized cash management system historically employed by O&Y. More importantly, however, without access to revenues from these assets there would have been no mechanism available to O&Y to finance its general, administrative and restructuring (or "GAR") expenses. The issue of who should fund the GAR costs occupied most of the time and energy of the participants in the restructuring during the months of May and June of 1992 and diverted time and resources from the pressing task of restructuring the enterprise.
In the result, a hybrid and unique type of funding was put in place, grounded on a two-pronged basis for financing: (a) the application of cash flow from secured assets, such as rental income from real property and dividends from securities, to cover the costs of managing the properties and to pay a management fee intended to cover overall GAR costs; and (b) the sale of unencumbered assets to generate further revenues to fund GAR costs.
This mechanism for financing GAR costs was far less efficient than the mechanism of DIP financing that was available south of the border in Chapter 11 proceedings. The absence of such a financing mechanism was an unnecessary impediment to the ability of Canadian debtors to effect a restructuring. As a result, in the decade that followed, Canadian courts borrowed the concept of and the term DIP Financing from Chapter 11 of the US Bankruptcy Code (the "Code") which, in s. 364 and related sections, sets out a detailed scheme for the provision of such financing. 4 They have not, however, adopted the US approach, 5 especially with respect to the "adequate protection" requirement contained in s. 364(d) and explained in s. 361 of the Code.
In contrast to the Code, the CCAA is relatively short, containing less than two dozen provisions, and does not explicitly address the availability of interim financing for the company. As stated by Justice Farley in Dylex Ltd., Re ("Dylex"), "the history of CCAA law has been an evolution of judicial interpretation". 6 Nowhere has the creativity and flexibility of the courts been more evident than in its development of the law relating to DIP financing under the CCAA.
THE JUDICIAL RECEIVERSHIP APPROACH
Until the early 1990s, the prevailing view was that the principles developed under the law regarding judicial receivers would apply equally to cases decided under the CCAA. In judicial receivership cases, financing for the debtor company was usually built into the permitted expenses and disbursements of the receiver, and priority was determined in accordance with the principles enunciated by the Ontario Court of Appeal in Robert F. Kowal Investments Ltd. v. Deeder Electric Ltd. 7 ("Kowal"). In that case, a receiver had been appointed by the court in respect of the assets of a partnership on the application of some of the partners, without the consent of a mortgagee in whose favour partnership lands were encumbered. The dispute arose as to whether the receiver should be granted a charge over the assets of the partnership ranking in priority to the mortgage for amounts advanced in respect of payments made on the mortgage debt during the course of the receivership. The Court of Appeal refused to grant the receiver priority status. Essentially, the court held that the receiver’s right to indemnity was restricted to the assets under his control, and confined to the equity of the debtor in those assets. As a general rule, there was no power in the receiver to subordinate the security of existing creditors in favour of his own expenses and disbursements. There were, however, three exceptions to the general rule:
- if a receiver had been appointed at the request of or with the consent or approval of the holders of security, the receiver would be given priority over the security holders;
- if a receiver had been appointed to preserve and realize assets for the benefit of all interested parties, including secured creditors, the receiver would be given priority over the secured creditors for charges and expenses properly incurred by him; and
- if the receiver had expended money for the necessary preservation or improvement of the property, he might be given priority for such an expenditure over secured creditors.
One of the first cases to consider the issue of financing for the debtor under the CCAA was Fairview Industries Ltd., Re8 ("Fairview"), a decision of the Nova Scotia Supreme Court. In that case, an initial order had been granted under the CCAA on an ex parte basis on the application of Fairview Industries Limited and five related companies. The initial order issued by the supervising court in those CCAA proceedings included, among other things, provisions permitting the monitor and certain restructuring professionals retained by the companies to be paid in priority to all other creditors of the applicants. After receiving notice, several secured creditors moved to rescind or vary the order, including the provisions relating to the priority of professional and administrative costs.
It was submitted by Fairview that "...the amount of work involved in these applications, including the ongoing work of preparing a plan, is substantial and that without priority of payment the six companies could be left without professional assistance to pursue the stated ends of the C.C.A.A.". 9 While the court sympathized with the position of the companies, it nonetheless held that it did not have the authority to subordinate pre-existing secured claims: 10
Although this position may have some validity, an analysis of the legislation does not lead me to conclude that such an extension can be attached to the wording of the C.C.A.A. Although such advisors and professionals must be paid, payment in priority to all of the creditors could result in deterioration of the value of the security held by the creditors.
The court therefore concluded that "...the payment in priority to anyone other than the monitor was void ab initio". 11 With respect to the priority position of the monitor, the court went on to state: 12
As to the court-appointed monitor, it is with reluctance that I conclude that although the court has the power to appoint such a monitor, there is no jurisdiction in the C.C.A.A. to give the monitor priority of payment unless the parties agree.
Therefore, the circumstances under which a monitor would be granted priority for its costs were highly circumscribed in the early days of the CCAA revival.
THE CCAA AND INHERENT JURISDICTION
The approach of the courts shifted in 1992, with the decision of the British Columbia Supreme Court in Re Westar Mining Ltd. 13 ("Westar"). In that case, the initial order granted by the court required suppliers of goods and services to extend further credit to Westar beyond the date of the initial order. The court subsequently held that it did not have the jurisdiction to make that particular order and, as security for credit which had been extended to the debtor company in the interim period (up to a limit of $17 million) and to secure any further credit which suppliers might be willing to extend to assist in the restructuring, created a first charge over Westar’s interest in the Greenhills mine. The mine was subject to a joint venture agreement with Pohang Steel, which included covenants in favour of Pohang that Westar would bear 80 per cent of the development, operating and reclamation costs relating to the mine and would keep its interest in the mine unencumbered. Over the objections of Pohang, the court reviewed and upheld its jurisdiction to create the charge.
In his decision, Justice Macdonald specifically rejected the application of the receiver-manager approach in the CCAA context, stating that he preferred to "...revert to what is fair and just in the particular circumstances of this case". 14 The charge in question had been created pursuant to the exercise of the "inherent jurisdiction" of the court, and the analogy to the powers and priority which may be granted by the court to a receiver-manager was neither necessary nor appropriate to support the exercise of such jurisdiction. Indeed, Macdonald J. held, 15
...different considerations apply. In the receiver-manager cases it is the property which is being safeguarded by the court. Under the C.C.A.A. it is the survival of the company which owns the property, for long enough to present a plan of reorganization, that is the court’s concern. In my view, the three exceptions to the "general rule"…do not exhaust the circumstances, under the C.C.A.A., in which the court may "authorize expenses for the carrying on of the business".
This position was more recently approved and reasserted by the British Columbia Court of Appeal in United Used Auto & Truck Parts Ltd., Re16 ("United Used Auto"), the only appellate level decision to date regarding interim financing for a debtor company, where the court stated: 17 . ..[T]he Kowal statement of exceptions has been influential in subsequent cases…. But as Macdonald J. observed in Westar Mining … different considerations apply under the CCAA. The court is concerned with the survival of the debtor company long enough to present a plan of reorganization. That is a broader interest than that of creditors alone. The jurisdiction must expand from the Kowal exceptions to serve that broader interest. Thus the receivers’ jurisdiction and the monitors’ jurisdiction are analogous to the extent that they are both rooted in equity but they diverge to the extent that the monitors’ jurisdiction serves a broader statutory objective under the CCAA. In my opinion the jurisdiction under the CCAA cannot be restricted to the Kowal exceptions.
As noted above, the court in Westar held that the inherent jurisdiction of the court provided legal justification for granting the charge. Citing the Supreme Court of Canada’s decision in Baxter Student Housing Ltd. v. College Housing Co-operative Ltd. 18 ("Baxter"), the court recognized that "[i]nherent jurisdiction cannot, of course, be exercised so as to conflict with a Statute or Rule. Moreover, because it is a special and extraordinary power, it should be exercised only sparingly and in a clear case". 19 However, the court went on to state: 20
The issue is whether or not those suppliers who are prepared (or have been compelled, between May 14 and June 10) to extend the credit which will hopefully keep the Company operating during the period of the stay, should be secured. I have concluded that "justice dictates" they should, and that the circumstances call for the exercise of this court’s inherent jurisdiction to achieve that end....
The circumstances in which this court will exercise its inherent jurisdiction are not the subject of an exhaustive list. The power is defined in Halsbury’s (4th ed., volume 37, para. 14) as:
…the reserve or fund of powers, a residual source of powers, which the Court may draw upon as necessary whenever it is just and equitable to do so…
Proceedings under the CCAA are a prime example of the kind of situations where the court must draw upon such powers to "flesh out" the bare bones of an inadequate and incomplete statutory provision in order to give effect to its objects.
The court held that the company "...would have no chance of completing a successful reorganization without the ability to continue operations through the period of the stay". 21 In order to continue operations, the company required further limited credit from its suppliers. Thus, "...security which is sufficient, in the eyes of its suppliers, to justify the extension of some further credit" was considered a condition precedent to any such financing. 22 Considering "[t]he imporCommercial tance of the company’s operations to the southeast corner of the province in particular, and to the economy of the province as a whole", the court held that it should do whatever could be done to provide the company with the opportunity to develop a successful restructuring plan. 23 The charge was therefore upheld.
Two aspects of the Westar case merit specific attention. First, Westar’s interest in the Greenhills mine was unencumbered. It was therefore available for the purposes of providing security for the financing. Second, the case specifically dealt with the issue of the priority position of statutory liens relative to DIP financing. On this issue, Macdonald J. concluded that the inherent jurisdiction of the court did not extend to allow the court to alter the priorities established under statute. He therefore granted priority to the Crown to the extent of its existing liens arising under several property, mining and income tax statutes.
The first instance of a court granting super-priority financing over the express objections of an existing secured creditor is generally accepted to be the decision of Mr. Justice Houlden in the Dylex case. 24 In that case, Dylex had determined that it required a $30 million operating facility to meet its needs during the restructuring period. The obvious sources for the financing were its existing lenders, Royal Bank of Canada ("RBC") and Bank of Montreal ("BMO"), who were, at the time of the commencement of the CCAA proceedings, owed approximately $90 million in the aggregate on account of term loans and leases. RBC and BMO held comprehensive security over virtually all of the assets of Dylex. When approached to provide the DIP financing facility, RBC took the position that it was prepared to provide the facility as long as BMO also agreed to participate. BMO refused to extend any further financing, but was willing to agree to a charge ranking equally with the existing security held by both banks for any advances made by RBC to Dylex during the course of the restructuring. In response, Dylex and RBC applied to the court for an order authorizing RBC alone to provide the financing, secured by a first charge on inventory and receivables ranking ahead of the existing security over such assets in favour of BMO and RBC, as well as a charge on all other assets of Dylex ranking behind the other security held by the two banks. Dylex also requested authority to pay to RBC an arrangement fee of $1 million in consideration for the establishment of the new facility. BMO opposed the application. In the end, Houlden J. approved the DIP financing as negotiated between RBC and Dylex, giving only the following brief reasons for doing so: 25
I do not believe that the Bank of Montreal will be adversely affected by the making of this order. As a result of the bridge financing, new receivables will be generated which will assist in re-paying or securing the bridge financing.
The issue was next visited in Skydome Corp., Re26 ("Skydome"), a decision of Mr. Justice Blair. In that case, Skydome Corporation, Skydome Food Services and SAI Subco Inc., all related (collectively, "Skydome"), applied for an initial order under the CCAA. Under the initial order, the companies requested authorization to borrow up to $3.5 million from the Blue Jays baseball club, a tenant of Skydome, to finance operating expenses and to pay certain capital expenditures and restructuring costs, secured by a charge ranking ahead of existing encumbrances. Finally, Skydome sought access to the $1.26 million held in a capital reserve account with Montreal Trust Company of Canada, which was held as part of the security arrangements regarding (with default ramifications taken into account) approximately $70 million of outstanding indebtedness to a group of Skydome bondholders. The bondholders objected to both the DIP financing charge and the use of the funds in the reserve account. Mr. Justice Blair held that there was "...ample authority in previous decisions of the Court for the granting of a Super Priority in CCAA situations" and to permit the debtor to spend cash and other encumbered current assets. 27 Noting that there was no evidence before him that it was "...in anyone’s interests for the Skydome to be shut down or, indeed, for the Blue Jays not to continue to play ball from that facility" and having considered the "...very substantial economic and financial ripple effects..." for the various stakeholders (including employees, merchants, suppliers, entertainers, the Toronto tourist industry generally and the various governments), Blair J. held: "...[T]here is a broader public dimension which must be considered and weighed in the balance on this Application as well as the interests of those most directly affected...". 28 With these various interests in mind, Blair J. went on to state: 29
As to the use of the funds in the capital reserve held by Montreal Trust, it makes sense in my view for them to be used for the purposes suggested by the Applicants. The Capital reserve fund withdrawal will be used for the YK2 [sic] enhancements, the improvements in the sound system, and the Hotel renovation — all of which will preserve the overall security. A significant portion of the total funds to be advanced, including the superpriority loan…will be used to pay Municipal taxes and Rent which are matters that have priority over the Bondholders in any event. Thus there is little overall prejudice in that regard.
Finally, Blair J. noted: 30
This is not a situation where someone is being compelled to advance further credit. What is happening is that the creditor’s security is being weakened to the extent of its reduction in value. It is not the first time in restructuring proceedings where secured creditors — in the exercise of balancing the prejudices between the parties which is inherent in these situations — have been asked to make such a sacrifice.
Thus, the court established that the exercise of discretion under the CCAA with respect to the granting of super-priority for DIP financing was to be based on a balancing of the relative prejudice to be experienced by the creditors with the benefit to be gained should the financing be granted. In this case, Skydome had succeeded in demonstrating to the satisfaction of the court that the benefits to be gained by the financing, in terms of preservation and improvement of assets, far outweighed the relative prejudice to be suffered by the creditors in terms of the dilution of their existing security, given the overall numbers involved.
Shortly after the initial application in Skydome, the issue of the subordination of pre-filing security interests to a charge securing DIP financing once again came before Blair J. in Royal Oak Mines Inc., Re31 ("Royal Oak"). The issue was also subsequently dealt with in a judgment of Farley J. in the case rendered shortly before the expiry of the initial 30-day stay period. 32
At the time of its CCAA application, Royal Oak, an operator of four gold and copper mines, had three main groups of secured creditors: (a) senior secured lenders, who were owed approximately $180 million; (b) a group of hedge lenders, who had advanced approximately $50 million and held security ranking behind that of the senior secured lenders; and (c) senior secured subordinated noteholders, who were owed approximately $264 million and whose security ranked behind that of the hedge lenders. The senior secured lenders and the noteholders supported the application. Although the hedge lenders did not oppose the granting of an initial order in principle, they opposed the subordination of their security to the DIP financing charge proposed by Royal Oak, considering it "...unnecessarily broad and ‘overreaching’, particularly where they had only been given short notice of the Application and where some creditors had been given none". 33
Justice Blair agreed that there was some cause for concern with respect to the growing complexity of the provisions contained in initial orders, which are generally presented to the court on short notice, and in prenegotiated, prepackaged form "...without the benefit of interested persons having the opportunity to review such terms and…to comment favourably or neutrally or unfavourably, on them...". 34 Justice Blair observed that CCAA orders would, of necessity, involve a certain complexity, but held that, 35
...what the Initial Order should seek to accomplish, in my view, is to put in place the necessary stay provisions and such further operating, financing and restructuring terms as are reasonably necessary for the continued operation of the debtor company during a brief but realistic period of time, on an urgency basis. During such a period, the ongoing operations of the company will be assured, while at the same time the major affected stakeholders are able to consider their respective positions and prepare to respond.
In keeping with these observations, Blair J. addressed the specific issue of DIP financing orders. While he apparently agreed that granting some form of DIP financing at the time of the initial application under the CCAA could be appropriate, he stated: 36
..[I]n my opinion, extraordinary relief such as DIP financing with super priority status should be kept, in Initial Orders, to what is reasonably necessary to meet the debtor company’s urgent needs over the sorting-out period. Such measures involve what may be a significant re-ordering of priorities from those in place before the application is made, not in the sense of altering the existing priorities as between the various secured creditors but in the sense of placing encumbrances ahead of those presently in existence. Such changes should not be imported lightly, if at all, into the creditors mix; and affected parties are entitled to a reasonable opportunity to think about their potential impact, and to consider such things as whether or not the CCAA approach to the insolvency is the appropriate one in the circumstances – as opposed, for instance, to a receivership or bankruptcy – and whether or not, or to what extent, they are prepared to have their positions affected by DIP or super priority financing.
Although Blair J. recognized that the hedge lenders had not been given a reasonable opportunity to consider their position and to instruct counsel, he authorized the creation of a first priority charge for DIP financing for the first month of the restructuring period in the amount of $8.4 million. Justice Farley, who subsequently took over carriage of the Royal Oak file, approved the initial DIP financing, stating: 37
Aside from the question of the lienholders who have registered liens which but for the Initial Order granted by Blair J. (but subject to the comeback clause) would have priority over the DIP financing, I see no reason to interfere with this superpriority granted. It would seem to me that Blair J. engaged properly in a balancing act as to the $8.4 million of superpriority DIP financing as authorized…. Implicit in his analysis and part of the equation is the reasonably anticipated benefits for all concerned which derive from these sacrifices.
With respect to the lienholders, Farley J. reviewed the law, as set out in Baxter and Westar, and concluded that the court did not have the jurisdiction to disturb liens granted super-priority positions under statute. However, he went on to state that, even if he had concluded that the court did have the jurisdiction to grant super-priority over the subject liens, he would have declined to exercise that jurisdiction in the circumstances before him.
In November 1999, Justice Tysoe, of the British Columbia Supreme Court, was asked to approve an initial order in respect of a group of debtor companies in United Used Auto & Truck Parts Ltd., Re38 ("United Used Auto"). The order was sought on an ex parte basis, and included provisions authorizing the creation of a first ranking charge in the amount of $500,000 to secure the fees and disbursements of the monitor, its counsel, and counsel to United Used Auto, as well as an additional first priority charge to secure operating financing in the amount of $1.1 million. The President of United Used Auto had deposed that the DIP financing was "...essential for the purpose of allowing the Petitioners to acquire new inventory for the auto wrecking business, retain the professionals required for the restructuring and to generally bring the operating business back to life". 39
Justice Tysoe reviewed the case law on priority charges for DIP financing, and held that, while the court had the jurisdiction to grant super-priority status for financing, "...the inherent jurisdiction of the Court to subordinate existing security should only be exercised in extraordinary circumstances", citing Royal Oak in support. 40 While Tysoe J. agreed that the exercise of discretion to grant super-priority DIP financing involved a balancing of interests, he held that "...there should be cogent evidence that the benefit of DIP financing clearly outweighs the potential prejudice to the lenders whose security is being subordinated". 41 While the priority charge for administrative costs was upheld, albeit reduced to $200,000 rather than the $500,000 requested, Tysoe J. refused to authorize the first charge for the operating financing, stating: 42
In the present situation, while the DIP financing would obviously have a beneficial effect on the operating business, I am not satisfied that it is critical for the business to continue to operate or for the Petitioners to successfully restructure their affairs. Nor do I have sufficient confidence in the cash flow projections and the appraised values of the realty that I can conclude that the benefit of the DIP financing clearly outweighs the potential prejudice to the secured lenders.
The matter was heard by the British Columbia Court of Appeal in January 2000, making it the first appellate level court to consider the issue of superpriority charges under the CCAA. 43 The questions before the court were, specifically, the following:
- can a court grant a priority for the fees and expenses of a court-appointed monitor ahead of secured creditors without the consent of those creditors; and
- whether legal fees incurred by a debtor-in possession in connection with a proposed restructuring can be granted a similar priority.
With respect to the monitor’s fees and expenses, the court reviewed the case law relating to the purpose of the CCAA and held that "...the CCAA’s effectiveness in achieving its objectives is dependent on a broad and flexible exercise of jurisdiction to facilitate a restructuring and continue the debtor as a going concern in the interim". 44 The court then reviewed the principles set out in Kowal and subsequent cases with respect to the priority position of the judicial receiver, but went on to agree with the observations of Macdonald J. in Westar that, in the CCAA context, a broader interest was at stake, and that, in recognition of the broader purposes of the legislation, the jurisdiction of the court in the CCAA context could not be limited to the exceptions set out in Kowal.
With respect to the super-priority charge for the fees of the debtor company’s counsel and restructuring advisors, the court held that such charges represented "a substitute for DIP financing". Consequently, "...the jurisdictional issue turns on the power of the court to allow a super-priority for DIP financing". 45 Citing the orders in Dylex and Skydome in support, the court upheld the jurisdiction of the court to create a superpriority charge, holding that this jurisdiction stemmed from the same equitable foundation as the monitor’s fees and disbursements. The court went on to state: 46
Dickson J.A. pointed out in [Braid Builders Supply & Fuel Ltd. v. Genevieve Mortgage Corp. 47] that receivers will not accept an appointment without reasonable assurance that they will be paid. That is equally true for monitors. When, as here, the cash flow from operations is insufficient to assure payment and asset values exceeding secured charges are in doubt, granting a super-priority is the only practical means of securing payment. In such circumstances, if a super-priority cannot be granted without the consent of the secured creditors, then those creditors would have an effective veto over CCAA relief. I do not think that Parliament intended that the objects of the Act could be indirectly frustrated by secured creditors.
In my opinion, an equitable jurisdiction is available to support the monitor which is sufficiently flexible to be adapted to the monitor’s role under the CCAA. It is a time honoured function of equity to adapt to new exigencies. At the same time it should not be overlooked that costs of administration and DIP financing can erode the security of creditors and CCAA orders should only be made if there is a reasonable prospect of a successful restructuring.
Presumably, since the same considerations apply to super-priority charges for monitor’s fees, legal and restructuring fees of the debtor company and broader DIP financing, the comments made above would apply to all three circumstances.
As noted above, the courts in Westar and Royal Oak both held that super-priority status for administrative expenses and DIP financing could not disrupt the priority status given to statutory liens. In the recent case of Sulphur Corp. of Canada Ltd., Re48 ("Sulphur"), several builders’ lien claimants brought an application before the Alberta Court of Queen’s Bench to determine whether the court had the jurisdiction under the CCAA to grant a DIP financing charge which would rank in priority to liens registered under the Builders’ Liens Act of British Columbia. Justice LoVecchio held that the court did indeed have such jurisdiction. Interestingly, rather than relying solely on the inherent jurisdiction of the court to grant orders to "fill in the gaps" in the CCAA, LoVecchio J. looked to the language of ss. 11(3) and 11(4) of the CCAA. Although these sections address stays of proceedings on initial and subsequent applications, and not DIP financing, both permit a court to "make an order on such terms as it may impose". Although he recognized that neither section mentioned the power of the court to create and give priority to a DIP financing charge, LoVecchio J. stated, after reviewing the case law relating to the purpose and function of the CCAA, that: 49
Parliament’s way of ensuring that the CCAA would have the necessary force to meet this objective [to foster restructuring and, consequently, the preservation and enhancement of an insolvent company’s value] was to entitle the Courts, pursuant to s. 11, to exercise its discretion and no specific limitations were placed on the exercise of that discretion.
Consequently, the provisions of the provincial Builders’ Liens Act conflicted with the provisions of the CCAA, a federal statute, and the doctrine of paramountcy applied. Where a conflict existed between the CCAA and a provincial or another federal statute, the CCAA would prevail.
Turning to the question of whether or not he should exercise his jurisdiction to override the liens registered under the provincial statute, LoVecchio J. noted that Sulphur had a working capital deficiency of over $9 million and that the possibility of obtaining funding from any party other than Proprietary, the shareholder who had agreed to provide the interim financing, was "an illusion". Sulphur would therefore have no chance to recover or restructure but for the provision of the financing on a super-priority basis, and the best chance for the lienholders to be paid was on completion of a successful restructuring. The prejudice to be suffered by the lienholders was therefore significantly outweighed by the benefits to be realized by all parties should the financing be authorized. The court therefore approved the financing and granted it super-priority status over the registered provincial liens.
Another interesting development in the area of DIP financing was the decision of the Alberta Court of Queen’s Bench in Hunters Trailer & Marine Ltd., Re50 ("Hunters"), where the court held that the jurisdiction of the court to authorize super-priority status for DIP financing can be extended to amounts advanced to the debtor company prior to, but in anticipation of and preparation for, the initial order. So long as the monies in question were "...reasonably advanced to maintain the status quo pending a CCAA application or the costs were incurred in preparation for the CCAA proceedings, justice dictates and practicality demands that they fall under the super-priority granted by the Court. To deny them priority would be to frustrate the objectives of the CCAA". 51
SOURCES AND TYPES OF DIP FINANCING
In Royal Oak, Farley J. stated that "[f]unding of DIP financing necessary for a CCAA applicant to carry on operations should not be restricted to any one source. It may be in certain situations that some or all of the existing creditor body would find it attractive and in their best interest to be a source of such funding". 52 In keeping with these comments, a variety of orders have been granted by the courts authorizing interim financing for the debtor company, through DIP financing or otherwise. Examples include orders authorizing:
- use of accounts receivable of a debtor company to secure DIP financing;
- loans from existing lenders or new DIP lenders with priority over previously unencumbered assets;
- loans from existing lenders or new DIP lenders with priority over encumbered assets;
- continued extension of credit to the debtor company by existing suppliers of goods and services, with priority over some or all existing security;
- loans from shareholders with priority status over some or all existing security; and
- the incorporation of financing into the monitor’s charge and the administrative charge with priority status over some or all existing security.
SUMMARY OF GENERAL PRINCIPLES
The following general principles with respect to DIP financing can be distilled from the cases discussed above:
- a company with a viable basis for restructuring will be permitted to borrow funds for working capital and to grant security for such borrowings which ranks ahead of the claims of unsecured creditors (see Westar);
- super-priority DIP financing will be approved where all or substantially all of the existing secured creditors consent to the charge;
- the interests of existing secured creditors can be prejudiced by the granting of super-priority DIP financing only if the court is satisfied that this is justified in the particular circumstances of the case before it (see Skydome);
- deciding whether to grant super-priority DIP financing is an exercise of balancing the interests of the debtor and its stakeholders, but "cogent evidence" will be required that the benefit of the DIP financing clearly outweighs the potential prejudice to secured creditors before the court will exercise its jurisdiction (see Royal Oak, United Used Auto);
- the requested financing should be kept to what is reasonably necessary to allow the company to continue to operate and to meet expenses required to "keep the lights on" while the company is attempting to restructure its affairs (see Royal Oak, United Used Auto);
- following the decision in Hunters, it appears that the court’s inherent jurisdiction may, in some cases, extend so as to permit it to grant DIP financing super-priority over registered statutory liens which would otherwise be granted superpriority status by operation of statute; and
- super-priority DIP financing may extend to cover advances made to the debtor company prior to the issuance of the initial order where such advances were made in connection with or in preparation for the proceeding.
PARLIAMENTARY REVIEW AND STATUTORY REFORM
In May 2003, the Standing Senate Committee on Banking, Trade and Commerce began a review of the BIA and the CCAA with a view to determining whether the legislation, as currently drafted, is meeting the needs of the full range of stakeholders it is intended to benefit and to make recommendations with respect to statutory reform. The final report of the Committee was released in November 2003. 53
With respect to DIP financing, the Committee agreed that provisions should be incorporated into the CCAA, stating: 54
...[I]f DIP financing is to be used, the Committee believes that the Court should be provided with some guidance in deciding whether to approve this financing… In our view, the entity providing the financing should be compensated for the risk that it is taking, but existing secured creditors should receive notice that the Court is contemplating the approval of DIP financing and a DIP lien that would have priority over their interests. The availability of DIP financing, criteria to guide the Court’s decision making, notice to secured creditors and priority for DIP lenders would help to meet several of the fundamental principles [of restructuring legislation] identified by us…including fairness, predictability and efficiency....
The Committee adopted the criteria developed by the Joint Task Force on Business Insolvency Law Reform, comprised of members of both The Insolvency Institute of Canada and the Canadian Association of Insolvency and Restructuring Professionals, which stressed the link between the granting of interim financing and the governance of the company during the restructuring period and suggested that the following seven factors should be considered by the courts in deciding whether or not to grant its discretion to grant DIP financing:
- what arrangements have been made for the governance of the debtor during the proceedings;
- whether management is trustworthy and competent and has the confidence of significant creditors;
- how long will it take to determine whether there is a going concern solution, either through a reorganization or a sale, that creates more value than liquidation;
- whether the DIP loan will enhance the prospects for a going concern solution or rehabilitation;
- the nature and value of the assets of the debtor;
- whether any creditors will be materially prejudiced during that period as a result of the continued operations of the debtor; and
- whether the debtor has provided a detailed cash flow for at least the next 120 days.
It is interesting to note that the focus of the inquiry was not the jurisdiction of the court to grant super-priority financing, but rather the considerations which should guide the court in determining whether the circumstances rendered the exercise of its jurisdiction appropriate in directing that the right of the court to sanction DIP financing on a super-priority basis seems to have been at this point to have been accepted in principle.
THE US APPROACH
In contrast to the approach under the CCAA, the US Code explicitly addresses the issue of interim financing. The main provision of the Code relating to DIP financing is s. 364, which addresses various methods by which a debtor or a trustee may be permitted to obtain credit or incur debt during the course of a bankruptcy proceeding, including a restructuring under Chapter 11.
Procedurally, the Code requires that there must be notice and a hearing before the court approves postfiling financing other than unsecured financing obtained in the ordinary course of business to cover actual and necessary costs of preserving the estate. This type of financing receives administrative expense priority without a court order.
If the debtor company or the trustee is unable to obtain unsecured financing, the court may authorize DIP financing which will either: (a) be given priority over certain administrative expenses; (b) be secured by a lien on previously unencumbered property; or (c) be secured by a junior lien on encumbered property.
The court is only permitted to authorize DIP financing that is secured by a lien that is equal or senior to an existing lien where the trustee or debtor company is unable to obtain the required credit without such priority ranking and there is "adequate protection" available to cover the interests of the existing security holders in the assets over which security is to be granted.
Section 361 of the Code provides that, in the case of secured DIP financing, adequate protection may be provided by:
- a cash payment or periodic cash payment to the existing secured party to the extent that the granting of the senior or equal lien by the court results in a decrease in value of the secured party’s interest in the property;
- an additional or replacement lien to the existing secured party to the extent that the granting of the senior or equal lien by the court results in a decrease in value of the secured party’s interest in the property; or
- such other relief (other than ranking as an administrative expense) as will result in the realization by the existing secured party of the "indubitable equivalent" of such secured party’s interest in the property.
In addition, s. 363 of the Code permits a debtor company that is pursuing a restructuring under Chapter 11 to use the cash collateral of a secured creditor. Such action requires express judicial authorization, which can only be given following notice and an opportunity for objecting parties to have a hearing. In order to authorize the use of cash collateral, the court must be satisfied that the secured creditor in question will be provided with adequate protection, as discussed above.
A RECENT CASE STUDY: IVACO INC.
Ivaco Inc. ("Ivaco") is a Canadian corporation that was, prior to the recently completed going concern sale of its primary businesses in the context of CCAA proceedings, a leading North American producer of steel, fabricated steel products and precision machined components. Ivaco’s principal products were wire rods, wire and wire products, fasteners and precision machined components. Ivaco’s revenues were generated by sales to a diverse group of customers located throughout North America that manufactured products for the automotive, construction, heavy machinery, transportation, communication, industrial manufacturing, oil and gas and other industries.
On September 16, 2003, Ivaco, along with related companies, including the general partners of Ivaco Rolling Mills Limited Partnership ("IRM") and Ifastgroupe and Company, Limited Partnership ("Ifastgroupe") (two limited partnerships of which Ivaco or its wholly-owned subsidiaries were the sole partners) applied for and received, an Initial Order under the CCAA. In its application material and draft order, Ivaco emphasized its need for DIP financing in order to fund its working capital needs and the costs of the restructuring. At that date, Ivaco did not have any material unencumbered assets and, in the absence of DIP financing with priority status, would have had no choice but to liquidate its assets.
Prior to making the initial application under the CCAA, Ivaco had approached a number of prospective lenders about the possibility of obtaining DIP financing, including its existing secured lender, National Bank of Canada ("National"). After reviewing several competing proposals, Ivaco determined that the most favourable terms were offered by GE Canada Finance ("GE"), which was already a major creditor of Ivaco pursuant to numerous capital leases. However, while GE was willing to provide the DIP financing facility requested by Ivaco, it was not willing to have its security rank prior to the security held by National without National’s consent which was not forthcoming. Accordingly, Ivaco, IRM, Ifastgroupe and GE formulated a structure whereby primary financing would be provided by GE to IRM and Ifastgroupe, to be secured by senior ranking security interests over all of the assets of IRM and Ifastgroupe, subject only to existing registered capital leases and registered mortgages on real property.
IRM and Ifastgroupe would then provide DIP financing to Ivaco, which would be secured by a charge over all of the assets of Ivaco, but subordinate to National’s existing security. Finally, it was agreed that Ivaco would provide DIP financing to Docap, one of its subsidiaries, pursuant to a separate term sheet, which financing would be secured by a charge over the assets of Docap, but again subordinate to existing security held by National over such assets, existing registered capital leases and registered mortgages on real property.
While GE agreed to provide a facility amounting to, in the aggregate, $50 million, the initial application and draft order sought approval for only $15 million, which was considered sufficient to cover the working capital requirements of Ivaco, IRM, Ifastgroupe and Docap during the first 30 days of the restructuring. Nevertheless, a number of the affected unsecured creditors took issue with the request, claiming that the financing resulted in a dilution of the asset base over which they had claims while providing no corresponding benefit. Justice Farley considered the "financial conditions of the Applicants, including the liquidity problems they have, the integration of their operations and the financial links [between the Applicants] to the extent they exist and held that the DIP financing, as proposed, was appropriate in the circumstances". 55
In particular, Farley J. noted that: 56
For the time being, it appears that the DIP arrangements have been reasonably reduced to a satisfactory level which may be equated to keeping the lights on. After review, if it is felt that the levels were to be inappropriate, then this may be addressed as per the comeback timing above…. In authorizing a DIP facility, not only is the Court concerned with a balancing of the prejudices but also with weighing the cost/benefit ratio (based on reasonably anticipated benefits if the reorganization reasonably proceeds). Drawdowns on the DIP facility should be on a "DRIP" basis — in other words, only so much as is reasonably necessary in the circumstances. On the other hand, I am of the view that it was appropriately recognized that while $1 million dollars is a material amount of money, this magnitude should be viewed in light of the overall scale of the organization. I would not therefore think it productive if molehills were magnified into mountains in any request for fine tuning. I note that E&Y concluded on a monitor-type analysis that the GE DIP proposal was superior to the other proposals, including those from existing financiers.
While materials filed with the court emphasized the integration of the businesses of IRM and Ifastgroupe with Ivaco, they also recognized that each member of the group was a separate legal entity with different stakeholders, including creditors. However, as noted above, the court approached the issue of DIP financing on a consolidated basis, looking to the relative prejudice to be suffered and the benefits to be gained by all stakeholders as a unified group and not on an enterprise-by-enterprise basis. This approach reflects the evolving flexibility of courts in responding to issues raised by DIP financing and the willingness of courts to do what is necessary to ensure that a debtor company is provided with a solid opportunity to restructure its operations.
1 R.S.C. 1985, c. B-3, as amended.
2 R.S.C. 1985, c. C-36, as amended.
3 See orders of the court in that case dated September 18, 1992, December 9, 1992 and February 8, 1993.
4 Discussed below, see "The US Approach".
5 In this respect, see Royal Oak Mines Inc., Re,  O.J. No. 864 (QL), 7 C.B.R. (4th) 293 (Gen. Div. – Commercial List) where Justice Farley refused to admit into evidence an affidavit sworn by Prof. Kenneth Klee dealing with the US experience under s. 364 of the Code, stating (at 298): "It is inappropriate to import concepts and tests from other jurisdictions; Canadian problems are to be resolved by Canadian concepts and tests".
6 Dylex Ltd., Re,  O.J. No. 595 (QL), 31 C.B.R. (3d) 106 (Gen. Div. – Commercial List).
7 Robert F. Kowal Investments Ltd. v. Deeder Electric Ltd. (1976), 9 O.R. (2d) 84 (C.A.).
8 Fairview Industries Ltd., Re,  N.S.J. No. 453 (QL), 11 C.B.R. (3d) 43 (T.D.).
9 Ibid., Fairview, at 59.
10 Ibid., Fairview, at 59-60.
11 Ibid., Fairview, at 60.
13 Re Westar Mining Ltd.,  B.C.J. No. 1360 (QL), 14 C.B.R. (3d) 88 (S.C.).
14 Ibid., Westar, at 94.
15 Ibid., Westar, at 93-94.
16 United Used Auto & Truck Parts Ltd., Re,  B.C.J. No. 409 (QL), 16 C.B.R. (4th) 141 (C.A.).
17 Ibid., United Used Auto, at 150.
18 College Housing Co-operative Ltd. v. Baxter Student Housing Ltd.,  2 S.C.R. 475.
19 Ibid., College, at 480.
20 Westar, supra, note 13, at 93.
21 Ibid., Westar, at 90.
23 Ibid., Westar, at 95.
24 Dylex Ltd., Re (January 23, 1995), Doc. B-4/95 (Ont. Gen. Div.), cited in David B. Light, "Involuntary Subordination of Security Interests to Charges for DIP Financing under the Companies’ Creditors Arrangement Act" (2002), 30 C.B.R. (4th) 245.
25 Ibid., cited in Light, at 263.
26 Skydome Corp., Re (1998), 16 C.B.R. (4th) 118 (Ont. Gen. Div. – Commercial List).
27 Ibid., Skydome, at 122.
28 Ibid., Skydome, at 121.
29 Ibid., Skydome, at 123.
31 Royal Oak Mines Inc., Re,  O.J. No. 709 (QL), 6 C.B.R. (4th) 314 (Gen. Div. – Commercial List).
32 Royal Oak, supra, note 5.
33 Royal Oak, supra, note 30, at 316.
34 Royal Oak, supra, note 30, at 319.
35 Ibid., Royal Oak, at 321.
36 Ibid., Royal Oak, at 321-22.
37 Royal Oak, supra, note 5, at 301-302.
38 United Used Auto & Truck Parts Ltd., Re,  B.C.J. No. 2754 (QL), 12 C.B.R. (4th) 144 (S.C.).
39 Ibid., United Used Auto, at 148.
40 Ibid., United Used Auto, at 152.
41 Ibid., United Used Auto, at 153.
43 United Used Auto, supra, note 16.
44 Ibid., United Used Auto, at 146.
45 Ibid., United Used Auto, at 150.
46 United Used Auto, supra, note 16, at 152.
47 Braid Builders Supply & Fuel Ltd. v. Genevieve Mortgage Corp.,  M.J. No. 31 (QL), 17 C.B.R. (N.S.) 305 (C.A.).
48 Sulphur Corp. of Canada Ltd., Re,  A.J. No. 918 (QL), 319 A.R. 152 (Q.B.).
49 Ibid., Sulphur, at 158.
50 Hunters Trailer & Marine Ltd., Re,  A.J. No. 857 (QL), 27 C.B.R. (4th) 236 (Q.B.).
51 Ibid., Hunters, at 248.
52 Royal Oak, supra, note 5, at 301.
53 "Debtors and Creditors Sharing the Burden: A Review of the Bankruptcy and Insolvency Act and the Companies’ Creditors Arrangement Act", Report of the Standing Senate Committee on Banking, Trade and Commerce, November, 2003,
55 Unpublished Endorsement of Justice Farley dated September 16, 2003.
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.