Canada: Void "Ab Initio": The Dangers Of Insufficient Disclosure

While it is common practice in Canada to seek certain emergency orders on an ex parte basis (i.e. where only one party (and not the adversary) appears before a judge), applicants for such orders are held to a high standard of candour with the court. Recently, the Ontario Superior Court of Justice (Commercial List) took the unusual step of finding that the initial order (the "Initial Order") granting protection under the Companies' Creditors Arrangement Act (Canada) (the "CCAA") was void ab initio as against all of the applicants thereto (CanaSea Petrogas Group Holdings Limited (Re), 2014 ONSC 6116). This was because subsequently produced evidence did not support the Court's initial conclusions regarding the applicants' eligibility for CCAA protection. In reaching this decision, the Court was very critical of the applicants for not fulfilling their high obligations of candour and disclosure on the ex parte hearing.

In September 19, 2014, CanaSea Petrogas Holdings Limited ("CPGH"), a Canadian holding company, and its subsidiaries (the "Applicants") sought CCAA protection on an ex parte basis. The other Applicants included two Singaporean companies, one of which, CanaSea Oil and Gas Group Pte. Ltd. ("COGG"), was the issuer of certain notes representing 49% of the debt obligations of the Applicants, and two Saskatchewan companies, one of which, CanaSea Oil and Gas Limited ("COGL"), held the major assets of the group being petroleum and natural gas licenses.

At the ex parte hearing, the Applicants relied on what they purported to be unaudited financial statements and advised the Court that the Applicants were eligible for CCAA protection as they each (i) had liabilities in excess of $5 million, (ii) were unable to meet their obligations as they came due; and (iii) had finances "inextricably intertwined" through intercompany advances. The Applicants also advised the Court that, although the Singaporean company (COGG) was the issuer of the notes, its Saskatchewan subsidiaries were "on the hook" for the notes due to the intercompany obligations thereby bringing the Applicants within the insolvency and $5 million debt thresholds required by the CCAA. On the basis of these representations, the Court granted the Initial Order.

Subsequently, COGG's noteholders sought a declaration that the Initial Order did not apply to COGG alleging that their loan documents designated Singapore as the venue for dispute resolution and that COGG did not qualify for CCAA protection because it did not have assets or business in Canada. However, the evidence produced by the noteholders lead the Court to also question the eligibility of the other Applicants. More specifically, while the Applicants purported to have included in the evidence unaudited financial statements that proved their insolvency and liabilities in excess of $5 million; instead they included only profit and loss statements or general ledgers. These documents alone could not demonstrate insolvency or these requirements. In addition, there was no evidence of intercompany loans that supported their representation that the Applicants' finances were inextricably intertwined.

The Court held that its previous conclusions were, in fact, wrong and that there was no evidence of the Saskatchewan subsidiary's (COGL's) insolvency independent of COGG. While the Canadian holding company and the two Singaporean companies were insolvent and had liabilities in excess of $5 million, the holding company did not do business in Canada, and the Singaporean companies, which were the real debtors in the proceeding, had very little connection to Canada. The Court held that, had it previously been aware of these facts, it would not have exercised its discretion to grant the Initial Order and ordered the Initial Order void ab initio as against all of the Applicants. The Court also found that the Applicants had not fulfilled their statutory obligation under section 10(2)(c) of the CCAA to disclose all financial statements prepared during the year before their CCAA application and held that it was "not satisfied that the [A]pplicants had filled their high obligations of candor and disclosure on an ex parte application."

The Applicants sought leave to appeal from the Ontario Court of Appeal on the basis that they were denied procedural fairness. They argued that the lower court terminated the Initial Order for their failure to make full and frank disclosure and, had they known this was the issue, they would have been able to satisfy the lower court that the disclosure made was adequate.

A single judge of the Court of Appeal denied leave to appeal (CanaSea PetroGas Group Holdings Limited, 2014 ONCA 824). The Court disagreed with the Applicants' characterization of the lower court's decision as an issue of disclosure. Instead, it reiterated the deference given to CCAA judges and deferred to the lower court's findings. The Court also held that the Applicants were unable to provide any authority to support their assertion of a common law doctrine of "common enterprise insolvency" and, therefore, simply because the two Singaporean companies were part of a larger group headed by a Canadian holding company, they could not claim the benefit of CCAA protection in respect of debt incurred in Singapore that is governed by Singapore law.

This case demonstrates that applications for insolvency proceedings on an ex parte basis will require a high level of disclosure and candour with the court. Companies and individuals who are considering seeking court protection from their creditors on an ex parte basis must be careful to err on the side of caution and ensure that all relevant financial and other information is disclosed to the court and interpreted fairly. In addition, this case demonstrates that a solvent company may not be eligible for CCAA protection where only its affiliated companies are insolvent.

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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