Canada: Important Restrictions Placed On Use Of CBCA For Debt Restructurings

In a recent unreported decision denying approval of a plan of arrangement under the Canada Business Corporations Act (CBCA) proposed by Connacher Oil and Gas Limited, Justice C.M. Jones of the Alberta Court of Queen's Bench considered the solvency test that corporations must meet in order to obtain a final order approving a plan of arrangement under the CBCA1. Prior to Justice Jones' decision, courts had not considered the issue of whether, in order to grant a final order approving a CBCA arrangement, the court first needed to be satisfied that the entity emerging from the CBCA proceedings would not be insolvent. Justice Jones concluded that:

  1. In order to make a final order under the CBCA plan of arrangement provisions, the court must be satisfied that the entity emerging from the proceeding will not be insolvent; and
  2. It is not appropriate for the court to exercise its discretion to essentially "deem away" events of default which underlie the determination of whether the entity emerging from the proceeding will not be insolvent.

Connacher is an oil company engaged in the exploration for, and the development, production and marketing of bitumen. Due to the significant decline in the net realized price for its dilbit (an oil product created from bitumen) in late 2014 and its significant debt obligations, Connacher encountered severe liquidity problems. Connacher's main debts were a US$128.4-million First Lien Credit Agreement, and US$550 million and C$350 million in Senior Secured Second Lien Notes. Connacher sought to implement a plan of arrangement under the CBCA pursuant to which, among other things, the Senior Secured Second Lien Notes would exchange their Notes for common shares of Connacher and be offered to subscribe for US$35 million principal amount of new 12-percent second lien convertible notes. The plan of arrangement purported to make the First Lien debt "unaffected" under the arrangement and remain in place post closing. Connacher and a newly incorporated shell company, Arrangeco, were to amalgamate as part of the arrangement and emerge as a new company. Connacher submitted that the proposed plan of arrangement would lead to a reduction of its debt by approximately $1 billion and eliminate annual interest costs by about $80 million.

Under the CBCA plan of arrangement provisions, applicants first apply for an interim order to permit a meeting and vote on the plan by affected parties. If the vote is successful, the company will then apply for a final order to approve the plan.

Prior to Connacher's interim order application, the First Lien lenders, through their Administrative Agent2, issued a notice of default based on a cross-default provision in the First Lien Credit Agreement and had accelerated all amounts owing under the Credit Agreement – approximately US$127.8 million that Connacher admitted it could not pay (either at the time or following the implementation of the proposed plan of arrangement). The default under the First Lien Credit Agreement arose from the fact that Connacher did not make a scheduled interest payment under the Secured Second Lien Notes which were subject to the arrangement proceedings.

Justice Jones granted the interim order application, over the objections of the Administrative Agent, allowing Connacher to hold a vote of its shareholders and the Second Lien noteholders, who would be compromised under the Plan (the First Lien lenders did not get a vote as their rights were purportedly not being affected). The vote was held and the requisite shareholder and creditor approvals were obtained. The parties then appeared again before Justice Jones for the final order application. Connacher sought approval of its plan of arrangement and, among other things, a final order which contained a release provision that purported to waive the default that the First Lien lenders were relying upon for acceleration of the First Lien debt. The Administrative Agent opposed approval of the plan and the final order on the basis that, among other things, Connacher had not proved it would not be insolvent even if the plan was implemented (and was therefore unable to qualify as an applicant for a final order under the CBCA), and it was not fair or reasonable to waive the event of default and the First Lien lenders' rights and remedies, particularly where the First Lien lenders were not given a vote on the plan. In connection with the final order application, the Administrative Agent also filed an Affidavit from retired New York Judge Allan Gropper which opined that, as a matter of New York law (the governing law of the First Lien Credit Agreement), the Administrative Agent was entitled to accelerate amounts owing in the circumstances. Connacher argued, among other things, that it was not in default and therefore would be solvent after the plan of arrangement and that even if it was in default, the Court had the jurisdiction to waive that default.

Under the CBCA, to obtain approval of a plan of arrangement, the applicant must demonstrate that (1) the statutory procedures have been met, (2) the application has been put forward in good faith, and (3) the arrangement is fair and reasonable. One of the express statutory requirements is that the applicant must not be insolvent. In previous cases, where a company has been in financial difficulty, this requirement under the CBCA has sometimes been satisfied where there are multiple applicants, at least one of which is not insolvent at the time of the initial application. Connacher was attempting to do the same in its case by making the newly-incorporated (and solvent) Arrangeco an applicant alongside Connacher. However, the novel issue in this case was whether the solvency requirement also required the Court to be satisfied – at the time that the final order approving the arrangement was sought – that the emerging entity from the plan of arrangement would be "not insolvent". In this case, due to the acceleration by the First Lien lenders, even if the plan of arrangement was implemented, it was possible that the restructured Connacher would still be insolvent as it admitted that it could not pay the full amount of the First Lien debt. In prior cases, this concern over the solvency of the emerging entity had not arisen. There was no reported case in which a plan of arrangement had been approved with a potentially insolvent emerging entity and the case law had not yet clearly articulated the timing of the application of the solvency test: is the test applied at the time of the interim order, the final order, and/or on emergence?

The threshold issue stated by Justice Jones was: "does the Court have the jurisdiction to issue a final order under the CBCA where the entity emerging from the Arrangement will or might be insolvent?" Due to the request by Connacher to waive the alleged default asserted by the Administrative Agent and First Lien lenders, a related but distinct issue the Court considered was whether it was appropriate for the Court to exercise the broad power given to it under the CBCA arrangement provisions to waive an alleged event of default; in effect, waiving the potential problem of insolvency.

In a key decision for CBCA arrangement proceedings, Justice Jones determined that in order to grant a final order under the CBCA to approve a plan of arrangement, the Court must be satisfied that the resulting or emerging entity will not be insolvent. Combined with the existing case law finding that at the time of the application for approval of a plan of arrangement an entity must be solvent, Justice Jones confirmed and clarified that the arrangement provisions in the CBCA are to be used in circumstances of solvency. He stated that restructurings which effect a compromise of debtholder claims against insolvent corporations are more properly conducted under the provisions of applicable insolvency legislation, as opposed to the CBCA.

Justice Jones also cautioned against using the broad jurisdiction given to courts under the CBCA to relieve a party of its insolvency problems by, among other things, granting a release or a "no-default" order. He specifically stated that exercising the power in subsection 192(4) "to issue a no-default order should be limited to circumstances involving corporations which do not, at that point in time, require the order to assert non-insolvency in reference to alleged events of default which may have already taken place." While no-default orders may be issued to maintain the status quo, this should not extend to circumstances where there is an alleged default that existed prior to the application. In this case, between the interim order and final order application, the First Lien lenders brought an action in New York (the jurisdiction chosen for disputes under the First Lien Credit Agreement) for the accelerated amount of the First Lien debt. Therefore, the "no-default" order requested by Connacher may also have impacted an existing proceeding before a New York court.

In consideration of the fact that the First Lien lenders, whose alleged default was proposed to be waived by the final order sought by Connacher, were not provided a vote on the plan, Justice Jones also expressed concerns about using the arrangement provisions to compromise or arrange the claims of creditors that have not had an opportunity to vote on the proposed plan. This echoed the guiding principles of the arrangement provisions provided by the Supreme Court of Canada in BCE Inc v 1976 Debentureholders,3 stating that where legal rights are compromised, the affected parties should be given a right to vote and, in certain circumstances, even the compromise of economic rights may require a vote. In making his decision, Justice Jones also commented on the impact that the requested order would have on lenders, particularly foreign lenders – a significant and practical consequence of waiving rights of foreign lenders when those lenders do not even have a vote on the compromise of their rights.

The decision of Justice Jones – if followed by other courts – may put some limits on the use of the CBCA to implement balance sheet restructurings where insolvency legislation, such as the Companies' Creditors Arrangement Act, could more properly govern. Justice Jones stated: "I must resist efforts to persuade the Court to create, through the exercise of its powers under the CBCA, one element of the factual matrix, that being non-insolvency of the emergent entity, which I have concluded is an essential requirement for the exercise of its power to approve the Plan of Arrangement and, in so doing, extricate Connacher from otherwise potentially applicable insolvency legislation."

In a significant decision for creditors, and all interested parties, Justice Jones has clarified the CBCA plan of arrangement provisions as solvency legislation and provided caution to companies attempting to circumvent the use of insolvency legislation and/or circumvent financial problems by asking for a release or waiver, through legislative provisions that are not intended to deal with such situations.

Connacher's application for a final order was rejected. Subsequently, Connacher and the First Lien lenders were able to come to a consensual resolution, including addressing the notice of default which had been issued under the cross-default provisions and withdrawing the pending New York proceeding. The parties went back before Justice Jones for a new final order, being brought on a consensual basis, which was granted.

Footnotes

1. In the Matter of a Proposed Arrangement involving 9171665 Canada Ltd. and Connacher Oil and Gas Limited, Action No. 1501-00574, Calgary, Alberta, April 2, 2015.

2. Bennett Jones LLP represented Credit Suisse AG, Cayman Islands Branch, as Administrative Agent.

3. 2008 SCC 69.

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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Sean Zweig
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