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Introduction
Director and officer releases ("D&O Releases"), termed "third-party releases" in the context of releases granted further to a restructuring transaction, are often a crucial part of a successful "fresh start" for debtor companies seeking a future through restructuring or to consummate a transaction that will bring an end to an insolvency proceeding. In the 2008 landmark decision Metcalfe & Mansfield Alternative Investments II Corp., (Re),1 ("Metcalfe") the Ontario Court of Appeal held that courts may sanction plans of arrangement under the Companies' Creditors Arrangement Act2 ("CCAA") that provide releases to solvent third parties, such as directors and officers of a debtor company.
The novel issue in Metcalfe was whether the CCAA permits a plan to include releases of claims against third parties who are themselves not creditors or debtors and therefore parties to the plan. The court found that given the skeletal and remedial nature of the CCAA, so long as the third-party releases are reasonably connected to the restructuring, they are permissible. However, the jurisprudence following the ruling in Metcalfe is inconsistent on whether the nature of third-party releases in CCAA plans or transactions approved by a CCAA court are exceptional or commonplace. Two recent cases post - Metcalfe, Arrangement relative à Lion Electric Company3 ("Lion Electric") and Imperial Tobacco Canada Limited4 (" Imperial Tobacco"), illustrate this tension.
Lion Electric
In Lion Electric, the Lion Electric Company (the "Lion Group"), a company that produced electric vehicles and was most famous for providing electric school buses, sought a full D&O Release as part of a rectified Reverse Vesting Order ("RVO"), removing an earlier carve-out for three class action claims that included claims against former and current directors and officers.5 Several parties to the class action claims, the former underwriters of Lion Electric (the "Underwriters") and the former auditors of Lion Electric (the "Auditors") (collectively the "Class Action Parties"), objected to the removal of the carve-out.6
As part of the RVO, the Lion Group announced that it sought to be released from all claims and liabilities of past and present directors and officers, with the exception of claims for fraud or willful misconduct, claims that are not permitted to be released pursuant to section 5.1(2) of the CCAA, and claims that are covered by any insurance policy of the Lion Group (to the extent of any such available insurance).7 However, the proposed draft order submitted to the court contained "far broader wording aiming to cover, for all intents and purposes, everything under the sun and more."8
The Lion Group argued that full D&O Releases are customary in CCAA restructurings, directors and officers contributed significantly to the restructuring efforts, the Class Action Parties lacked standing as equity holders, and the remaining exceptions for fraud, wilful misconduct, and insured claims provided adequate protection.9The Class Actions Parties countered that the full D&O Release was overly broad and not necessary for the restructuring, which would have succeeded regardless of the contributions of directors and officers, that it was unfair, and that it did not benefit the debtors or creditors.10
The Superior Court of Quebec ("QCCS") dismissed the Lion Group's application. Although courts have often described this type of relief as extraordinary, in practice, it is frequently granted in CCAA restructurings. Here, however, the Court emphasized that third-party releases "are not and should not be granted as of right."11 Deviating from jurisprudential creep normalizing third party releases in CCAA proceedings, the QCCS reasserted that third-party releases are the exception – not the rule.12
In its analysis, the Court applied a set of factors to determine the connectivity between the third-party release sought and the outcome of the CCAA plan (the "Lydian Factors")13, the exercise of which is commonly referred to as theNexus Test.14 It found that the full D&O Release was not rationally connected to the purpose of Lion Group's restructuring plan as it was not a condition precedent for the RVO or necessary to achieve the transactions contemplated by it15, nor was there sufficient evidence that the directors and officers were meaningfully involved in or contributed to the restructuring process.16 Moreover, the class action claims wereprima facielegitimate, serious, and well-founded and thus must be heard.17 The full D&O Release unfairly prejudiced the Class Action Parties, contrary to section 5.1(3) of the CCAA, which affirms the court's discretion to deny D&O Releases where it would be unfair or unreasonable in the circumstances.18 Furthermore, the court noted that equity holders are not barred from raising legitimate concerns to their treatment under a CCAA plan, as the Class Action Parties were not seeking a financial claim against the assets of the debtor.19 Lastly, the remaining exclusions in the full D&O Release did not adequately protect the Class Action Parties.20
Imperial Tobacco
In Imperial Tobacco, four tobacco companies (the "Tobacco Companies") entered into CCAA protection to effect a global settlement of all tobacco-related claims in Canada (the "CCAA Plans").21 To obtain the settlement, the Tobacco Companies agreed to pay a sum of $32.5 billion in exchange for a release of all tobacco-related claims ("Tobacco Claims").22 The released parties included directors, officers, monitors, parent companies, and relevant affiliates to the Tobacco Companies.
In analyzing whether the third-party releases should be granted, the Ontario Superior Court of Justice ("ONSC") also applied the Lydian Factors. The Court found that the releases were negotiated as part of the overall framework of the compromises in the CCAA Plans and thus necessary to achieve the global settlement of the Tobacco Claims.23 Furthermore, each of the released third parties had or planned to contribute in a tangible way to the restructuring.24 The affected creditors received the CCAA Plans, participated in mediation, and supported the releases. The releases also did not exclude other carve-outs, such as fraud and criminal activity.25 They were not overly broad and were fair and rationally connected to the overall purpose of the CCAA Plans.26 The third-party releases were approved.27
Conclusion & Key Takeaways
Despite the contrast in the rulings by the QCCS and ONSC, courts in Canada tend to apply the following general principles in deciding whether to grant a third-party release:
- Judges have wide discretion in approaching third-party releases as part of restructuring plans;
- The factors considered in granting third-party releases are settled and include a consideration of (i) whether the released parties are necessary and essential to the restructuring of the debtor, (ii) whether the released claims are rationally connected to the purpose of the plan and necessary, (iii) whether the plan could succeed without the releases, (iv) whether the released parties meaningfully contributed to the plan, and (v) whether the release benefits the applicants and the creditors generally; and
- Where a full D&O Release seeks to impair third-party claims that appear sufficiently serious and well founded on a prima facie basis, as opposed to being fragile or speculative, the court will heavily scrutinize the request and likely refuse it.
Lion Electric, however, clarifies less settled areas of the law concerning third-party releases not addressed in Imperial Tobacco. For instance, equity holders can challenge releases impacting their rights. Their interests are not automatically barred, dismissed, or subordinated, so long as they do not make a financial claim. Furthermore, where a release is overly broad, opposed by creditors, and customary carve-outs do not provide sufficient protection to creditors, courts are more likely to refuse a third-party release.
Footnotes
5 Lion Electric at para 5.
6 Ibid.
7 Ibid at para 6.
8 Ibid at para 7.
9 Ibid at para 10.
10 Ibid at para 9.
11 Ibid at paras 60-61.
13 The Lydian factors are criteria the court considers when determining, at a minimum, whether the third-party releases are "reasonably connected to the proposed restructuring" (see ibid at para 62, referring to Lydian International Limited (Re) (Lydian), 2020 ONSC 4006 at para 53). They include: a) whether the parties to be released from claims were necessary and essential to the restructuring of the debtor; b) whether the claims to be released were rationally connected to the purpose of the plan and necessary for it; c) whether the plan could succeed without the releases; d) whether the parties being released were contributing to the plan; and e) whether the release benefited the applicants as well as the creditors generally (see Lion Electric at para 63, citing Arrangement relatif à Blackrock Metals Inc. (Blackrock), 2022 QCCS 2828 at para 130).
14 Ibid at para 66.
15 Ibid at para 162.
16 Ibid at paras 179-182, 191-194.
17 Ibid at paras 154-155, 160.
18 Ibid at paras 196-199, 332.
19 Ibid at paras 229-231.
20 Ibid at paras 359-360.
21 Imperial Tobacco at paras 15-17.
22 Ibid at para 18.
23 Ibid at para 198.
24 Ibid.
25 Ibid at para 201.
27 Ibid at para 204.
The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.
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