Canada: Court Affirms Priority Entitlement Of Canadian Creditors To Post-Liquidation Interest From Canadian Branch Of Foreign Insurance Company

On July 14, 2009, the Ontario Superior Court of Justice released its decision in Canada (Attorney General) v. Reliance Insurance Company, an application regarding the allocation of surplus arising from the liquidation of the Canadian branch (Reliance Canada) of U.S.-based Reliance Insurance Company (Reliance U.S.), a property and casualty insurer that was itself in liquidation. KPMG Inc., the liquidator of Reliance Canada, had sought advice and direction with respect to the entitlement of Canadian policyholders to interest on post-liquidation claims under the Winding Up and Restructuring Act (WURA) for claims made during the run-off period.

In his decision, Justice Colin Campbell acknowledged that the WURA is a difficult and sometimes contradictory statute to apply in respect of different kinds of financial institutions. Nevertheless, he affirmed that Canadian claimants are entitled to be paid from Canadian assets before any payments are made to a foreign liquidator. In particular, Justice Campbell found that, pursuant to section 95(2) of the WURA, the Canadian creditors of Reliance Canada were entitled to interest on allowed claims in the winding-up process, in priority to any release to Reliance U.S.

The Background

As the Canadian branch of a foreign insurance company, Reliance Canada was subject to solvency regulation by Canada's Office of the Superintendent of Financial Institutions (OSFI) under the Insurance Companies Act (ICA). After Reliance U.S. was ordered to be liquidated by the Commonwealth Court of Pennsylvania, OSFI assumed control of Reliance Canada's assets pursuant to the ICA. Following OSFI's recommendation, the Attorney General of Canada sought a winding-up of Reliance Canada, and in December 2001 the Superior Court of Ontario ordered the winding-up of Reliance Canada pursuant to the WURA.

The assets of Reliance Canada were held by KPMG separate from the assets of Reliance U.S., i.e. two separate estates were maintained. All policy claims settled prior to commencement of the winding-up were paid by Reliance Canada prior to the winding-up. Reliance Canada's policies were not cancelled, but continued to be run-off and settled in the normal course of claims adjudication. Throughout the course of the liquidation, the Court permitted payment of policy loss claimants with claims within certain limits as they were settled and allowed. The Court also granted Orders approving distributions to those claims above this limit by various interim dividend payments.

As a result, many policy loss claims were paid in full as they were settled and allowed, with no delay in payment suffered by the claimants (Under-limits Claimants). Other policy loss claims and certain reinsurance claims could not be paid in full as they were settled and allowed, however, as they exceeded the limits set by the Court (Over-limits Claimants). Consequently, the Over-limits Claimants suffered a delay in payment and were paid over time by way of interim dividend payments, resulting in a cumulative distribution of 100 cents on the dollar by April 8, 2008.

A procedural Order dated January 25, 2009 provided for the appointment of representative counsel for the two classes of claimants.

The Decision

As the Reliance Canada estate was ultimately in a surplus position, the question arose as to whether post-liquidation interest should be paid to Canadian policy claimants prior to any payments being made to Reliance U.S.

KPMG outlined its position to the Court that Part 1 of the WURA, in particular s. 9 and s. 95(2), applied to windings-up and codified entitlement to post-liquidation interest from a surplus. Pursuant to s. 95(2), the Canadian policyholders were entitled to 5% interest from the date of the Canadian liquidation order. In this case, KPMG argued that the appropriate group to receive interest was the Over-limits Claimants, who suffered a delay in receiving payment of their claims, with the appropriate start date to be calculated from the date the Over-limits Claimants would otherwise have been entitled to payment in the ordinary course (i.e., absent a liquidation) to the date of actual payment in full of principal and interest, with interim distributions to be applied first to interest, then principal.

Conversely, given the existence of Part III of the WURA, which governs insurance companies and is silent on the issue of surplus and post-liquidation interest, the liquidator of Reliance U.S. challenged the applicability of s. 95 to windings-up. Further, it questioned why the Court should exercise its discretion in favour of Canadian policyholders to permit them to receive interest when the creditors of Reliance U.S. would receive significantly less than the principal amounts of their policy loss claims. Finally, the liquidator of Reliance U.S. questioned why, even if interest was payable, it should be calculated at a rate greater than the 3.9% earned over the course of the winding-up.

In his decision, Justice Campbell affirmed that whatever assets Reliance U.S. had maintained in Canada in compliance with the ICA came under the jurisdiction of the Canadian winding-up court. The Court further held that a winding-up court sits to administer the assets within its jurisdiction and for that purpose the court administers the law of its jurisdiction on procedural and substantive matters. When a winding-up order is made for the Canadian business of a foreign company, the provisions of the Canadian statute apply and control the entire situation. As such, the Canadian winding-up is an independent and self-contained proceeding.

As noted above, Justice Campbell further concluded that the provisions of the WURA, in particular s.95(2), entitled Canadian policyholders to interest on allowed claims in the winding-up in priority to any release to Reliance U.S., at a rate of 5%. However, Justice Campbell found that only the Over-limits Claimants were entitled to such interest, to be calculated as simple interest at an annual rate of 5% on the unpaid portion of each Over-limits Claimant's allowed claim from the time such claim was settled and allowed until such claim was paid in full, with interim distributions to be applied first to interest, then principal.

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