Canada: The Bluberi CCAA Proceedings: Litigation Funding In Insolvency

On February 4, 2019, the Court of Appeal of Quebec released its decision in the matter of Callidus Capital Corporation and al. v. 9354-9186 Québec Inc. (formerly Bluberi Gaming Technologies Inc.).  With the increase in third party litigation funding, we are now seeing it being used in the insolvency context and the Court of Appeal is considering how litigation funding arrangements are to be utilized in Companies' Creditors Arrangement Act1 ("CCAA") proceedings. The Court answers the following question:

When a debtor company, subject to protection under the CCAA has no assets except a litigation claim, who should decide whether to pursue the claim or accept a settlement - the debtor or the creditors?

Spoiler alert - it's the creditors.

In a unanimous decision, the Court of Appeal opined that the March 18, 2018 lower Court decision in the Québec Superior Court was both tainted with palpable errors in the finding of facts and more importantly errors of law in the application of the CCAA. The Court of Appeal substitutes its understanding of what constitutes a plan of arrangement.

Bluberi Gaming Technologies Inc. ("Bluberi"2) is a company that sold games and casino machines. In 2012, Bluberi obtained financing from Callidus, an asset-based lender. On November 12, 2015, Bluberi sought protection under the CCAA. A sales and solicitation process was eventually authorized by the CCAA court and Callidus purchased substantially all of the assets of Bluberi through a credit bid.  As a result, Callidus' claim of $135.7 million against Bluberi was extinguished, except for an undischarged portion of $3 million not used in the credit bid. The sole remaining asset of Bulberi excluded from the credit bid arose from Bluberi's expressed intention to file a lawsuit for damages against Callidus (and others) for a significant amount (in the range of $200 million) ("Bluberi Retained Claim").

Bluberi sought a $20 million priority charge through a convoluted lending mechanism in favour of a joint  venture company created to be the litigation funder. Gerald Duhamel, the sole shareholder of Bluberi (through a family trust), was involved in the litigation funder.  This litigation funder would make $2 million available to Bluberi to finance the litigation of the Bluberi Retained Claim against Callidus. The charge was required to secure repayment of the loan and a success fee in favour of the litigation funder and Bluberi's lawyers. 

Callidus not only contested Bluberi's request but also filed a plan of arrangement under which $2.5 million was offered to Bluberi's creditors in exchange of a full and final release.

The CCAA judge ordered that Callidus' plan be presented to creditors and allowed Bluberi to file a competing plan.  Bluberi did file a plan but withdrew it a few weeks later, after the CCAA judge ordered that the fees and expenses related to the convening and holding of the creditors' meeting be shared equally between Callidus and the litigation funder.

Callidus' plan was approved by 92% of the creditors.  However, the threshold majority of two thirds in value of all unsecured claims was not reached because one creditor holding 36.7% of total claims voted against it.

A few months later, Bluberi requested that the CCAA Court approve a new litigation funding agreement ("LFA") and the granting of a priority charge of $20 million in favour of the litigation funder, IMF Bentham Limited ("Bentham"), and Bluberi's lawyers. Only a redacted version of the LFA was disclosed to Callidus and to the group of creditors (comprising former employees, a professional firm and a trade creditor) that had supported Callidus' plan.

Callidus replied by filing an amended plan of arrangement (increasing its offer to the creditors to $2,880,000) and, together with the creditors' group, sought an order from the Court:

  • Declaring that the LFA constitutes a plan of arrangement that needed to be approved by the required majority of creditors;
  • Convening a creditors' meeting during which both Callidus' amended plan and Bluberi's plan (should Bluberi elect to file one) would be considered;
  • Declaring that Callidus is entitled to vote any unsecured portion of its $3 million claim in favour of its own plan (which would likely allow its amended plan to attain the 2/3 in value threshold); and
  • Declaring that a full disclosure of the LFA was required.

The CCAA judge refused to issue such an order.  As summarized by the Court of Appeal, he concluded that the "Callidus plan of arrangement was motivated by its desire to obtain a release from the debtors' claim against it so that allowing it to vote would be 'unfair and unreasonable' and 'contrary to the purpose of the CCAA'." He also "determined that the whole scheme of suing Callidus, financed by Bentham under the LFA with considerable contingency fees payable to it as well as to the debtors' attorneys, did not constitute a plan of arrangement to be submitted to a meeting for approval by the statutory majority of creditors."  Finally, he refused to order a full disclosure of the LFA based on the concept of litigation privilege.

On April 20, 2018, Callidus and the Creditors' Group obtained leave to appeal and the hearing on the merits took place on December 3, 2018.  In its decision delivered on February 4, 2019, the Court of Appeal dealt with the various issues in the following order:

  1. Should Callidus have the right to vote on the plan of arrangement it proposed?
  2. Should Bluberi submit the LFA to a vote of the creditors by way of a plan of arrangement?
  3. Should a complete disclosure of the LFA be ordered?

To the first question, the Court deals with two arguments that may have precluded Callidus from participating in the vote, one stemming from legislation, the other from the trial judge's discretion.

The legislative argument advances that Callidus is related to the debtor and therefore barred from voting in favour of a plan, pursuant to section 22(3) of the CCAA. Bluberi and the Monitor argued that the alleged de facto control exercised by Callidus over the affairs of the debtor makes it a "related person".  The Court of Appeal found that "There is no validity to such argument (...).  "Related person" is defined in Section 4 of the BIA, to which Section 2(2) CCAA refers.  Voting control is required.  Callidus holds no shares nor the voting rights over any shares of either of the respondents".

The discretionary argument finds its source in the "improper purpose" doctrine, developed as a reason for a court to exercise its jurisdiction to dismiss or stay a petition for a bankruptcy order, even when faced with the two prerequisites to issue such an order (debt and an act of bankruptcy). The trial judge relied on a Nova Scotia Court of Appeal decision3 in which a creditor had purchased debt for the sole purpose of voting against a proposal under the BIA in order to bankrupt the debtor and eliminate a competitor from the marketplace.

The Court of Appeal recalled that voting rights are fundamental to the scheme of creditor democracy and that cancelling such rights on allegations of a yet to be instituted lawsuit is not an appropriate exercise of discretion.  The Court concluded on that point that "(...) Callidus seeks to vote its own claim, the quantum of which was previously approved by the judge. The self-interest it promotes is the release from the debtor's proposed litigation.  In consideration of the release, Callidus will fund payment to the mass of creditors on terms that the vast majority of such creditors wish to accept.  This is not an improper purpose either legally or on any interpretation of the facts of this case(...)."  In that respect, the Court of Appeal followed a number of previous cases in which plan sponsors (that are also creditors) were allowed to vote on a plan providing for a release in their favour and, moreover, to do so in the same class as the ordinary creditors4.

As for the second question, the appellate decision highlights the fact that the CCAA judge approved the LFA as interim financing, whereas he had previously ordered a similar scheme to be submitted to creditors as part of a plan of arrangement.

The Court of Appeal distinguishes Crystallex5, which was heavily relied on by the respondents as support for a restrictive interpretation of what constitute an "arrangement".  That decision involved creditors and the debtor competing to finance a litigation claim (which was the only remaining asset of the debtor).  The Ontario Court of Appeal approved the financing proposed by the debtor and determined that there was no need to submit it to a vote of the creditors, whose rights were considered by the Court not to be affected since the success fee of the lender was payable only after the payment in full of all the unsecured claims.  

As the Québec Court of Appeal pointed out, the Bluberi case offers a choice between litigation and settlement. In Crystallex, no such alternative was put forward.  According to the Court of Appeal, "compromise" or "arrangement" should be given a broad interpretation, in line with the remedial purpose of the CCAA. The Court of Appeal also referred to Metcalfe6, in which the Ontario Court of Appeal reasoned that an alteration of existing rights between debtors and creditors is not a necessary condition to the qualification of "arrangement".  

In any event, the Québec Court of Appeal concluded that the proposed LFA has the potential to significantly alter the creditors' rights as they could "very well receive nothing", considering that, pursuant to the LFA, the success fee ranks ahead of the unsecured claims:

"Bluberi Gaming is not operating and there is no indication that it will recommence any business operations. The Respondents' only "raison d'être" is the pursuit of the proposed litigation which is the only potential source of recovery for the creditors (other than the Callidus plan). As such, focusing on whether the LFA viewed in isolation altered creditors' rights is overly restrictive as an analysis to determine whether the scheme constitutes an arrangement. However, if I were to apply such criteria as a test, the scheme proposed by the Respondents with the LFA would qualify as an arrangement, since it allows the Respondents to decide with Bentham whether to accept any settlement of the litigation. The scheme sets the stage for "alteration of creditors' rights" as the reasons of the Court of Appeal in Crystallex would have it. They could very well receive nothing in a settlement where the funds generated were only sufficient to pay the lawyers and Bentham.

Sophistry aside, rather than being paid on normal contractual or commercial terms, the creditors are told to await the outcome of the prosecution of a litigious claim for the debtors to obtain cash to perhaps pay something at some future date. I think their legal rights are "taken away" or "compromised."

The Court of Appeal accordingly found that the CCAA judge's initial approach was the correct one: both plans should be submitted to the creditors for a vote, and in such case, related costs should be borne in equal parts.

Finally, the Québec Court of Appeal ordered that the creditors (except Callidus) be granted access to an unredacted version of the LFA (subject to the execution of a confidentiality agreement) in order to approve or reject any eventual Bluberi plan with open eyes.  It found that the redacted clauses contained essential information to evaluating the merits of the proposed financing, but that the concept of litigation privilege continues to apply to Callidus.

Litigation financing is relatively new in Canada but we see this practice expanding more and more, including in insolvency cases.

Following the decision of the Québec Court of Appeal, debtors, litigation funders and creditors should bear in mind that when the only "raison d'être" of the debtor is the pursuit of litigation, or when such litigation is at the core of any arrangement, pursuit of that litigation requires the approval of creditors that are also entitled to full disclosure of the terms and conditions of any proposed litigation funding agreement.

Also of importance is the decision of the Court of Appeal not to depart from the previous case law dealing with voting rights of creditors that are also sponsors of the plan of arrangement.  The right to file a plan of arrangement is not confined to the debtor.  The CCAA allows such a filing "in respect of" the debtor by a third party and this right is regularly exercised in a variety of circumstances.  A different approach by the Québec Court of Appeal on that point would have had a chilling effect on future cases involving creditor sponsored plans, which should be encouraged insofar as they facilitate a timely and satisfactory outcome for stakeholders.

Lastly, the judgement of the Court of Appeal illustrates that, while the broad discretion granted to the supervising judge is a cornerstone of the CCAA and should make an appeal court hesitant to interfere, it also has its limits and, as the Supreme Court of Canada stated in Sun Indalex, "courts should not use equity to do what they wish Parliament had done through legislation". 

Footnote

1 R.S.C. 1985, c. C-36

2 The company will continue to be referred as Bluberi, despite the fact that it no longer goes by that name.

3 Laserworks Computer Services Inc. (Re), 1998 NSCA 42

4 Re 4519922 Canada Inc., 2015 ONSC 4648; Muscletech Research and Development Inc., Re, 2006 CanLII 34344 (ON SC), para. 9; Canadian Airlines Corp. (Re), 2000 ABQB 442, paras. 103-104; Societe industrielle de décolletage et d'outillage (S/DO) It& (Arrangement relatif a), 2010 QCCA 403 (Bich, J.A.), para. 30

5 Crystallex (Re), 2012 ONCA 404

6 Metcalfe & Mansfield Alternative Investments II Corp., (Re), 2008 ONCA 587

Read the original article on GowlingWLG.com

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