Canada: Real Estate Development And Investment Companies Having Trouble Finding Shelter Under The CCAA

The Companies' Creditors Arrangement Act¹ (the "CCAA") is by far the most flexible Canadian law under which a corporation can restructure its business. When compared against the Bankruptcy and Insolvency Act² (the "BIA"), the CCAA looks like a blank canvass and lends itself well to invention and mutual compromise. The overarching goal of the CCAA is for the debtor corporation to formulate a plan of compromise or arrangement (a "Plan") that is approved by the corporation's creditors or to effect a going concern sale, both of which are intended to provide greater value to the creditors than if the debtor corporation were liquidated under the BIA.

Insolvency practitioners seem to prefer using the CCAA whenever a debtor corporation satisfies the statutory requirements, the main requirement being that at least $5 million is owed to creditors at the time of the debtor corporation's insolvency – not a high threshold in today's economic environment. However, proceedings under the CCAA are expensive and typically involve priority charges over the property of the debtor corporation for professionals, directors and officers of the debtor corporation, and interim financing ("DIP Financing"), which can have the effect of eroding creditors' realization. Despite the cost, the CCAA has become the go-to choice for debtor corporations that meet the statutory requirements.

Although it is flexible, the CCAA is not suitable to all types of businesses that meet its requirements. This reality has recently come to the attention of the Ontario Superior Court of Justice (Commercial List) (the "Court") in two cases before Mr. Justice Campbell, Re Dondeb Inc. ("Dondeb")³ and the parallel cases of Romspen Investment Corp. v. Edgeworth Properties, et. al.⁴ and Re Edgeworth Properties Inc., et. al.⁵ (collectively referred to as "Edgeworth").

Both cases share similar facts: the debtor corporations were in the business of real estate development and investment and had several single-purpose subsidiary corporations, each of which owned a discrete piece of real estate. Each piece of real estate was encumbered by at least one mortgage and many were cross-collateralized. Mortgages accounted for the vast majority of the first-ranking secured indebtedness. The debtor corporations sought protection under the CCAA and certain of their respective lenders opposed the application on the basis that it would be more advantageous for them to proceed with an orderly sales process under their respective mortgage security.

Dondeb

In Dondeb, the debtor corporation sought relief under the CCAA to enable a liquidation of its assets and property and that of its subsidiary or affiliated companies. DIP Financing and a charge to secure it, as well an administrative charge to secure the fees and expenses of the professionals involved in the CCAA administration, were all sought by the Debtors. The application was opposed by various secured lenders who collectively held approximately 75% of the value of the secured indebtedness. The basis for the opposition was that: (i) the properties would be more appropriately sold under the mortgage security; (ii) the DIP and administration charges unnecessarily burdened the equity of the properties; (iii) the lenders had lost all faith in management and its ability to generate revenue from the real estate; and (iv) no Plan would be realistically accepted by the lenders because there was no underlying business to restructure that would yield greater value for them than through enforcement of their own respective mortgage security.

In the result, the Court refused to grant the debtor corporation relief under the CCAA for the simple reason that a successful Plan could not be filed that would receive approval in any meaningful fashion from the creditors. Instead, Campbell J. issued a receivership order under the BIA which, in his view, would achieve an orderly liquidation of most of the properties and protect the revenue from the operating properties with the hope of the potential of some recovery of the debtor company's equity in those properties not "under water". Each property subject to the receivership was compartmentalized such that all of its revenues and expenses were allocated to that particular property. Justice Campbell noted that using the CCAA for the express purpose of a liquidation must only be done with caution, particularly when the alternative of an overall less expensive receivership can accomplish the same goal.

Edgeworth

The facts in Edgeworth are functionally equivalent to Dondeb, except that in Edgeworth, only one of the underlying properties was fully developed and there were several thousand secured and unsecured creditors independent of the first-ranking mortgagees. The applicant corporations sought relief under the CCAA as a means to provide a single comprehensive forum to address all stakeholder claims. The mortgagees opposed the application on grounds similar to those in Dondeb, including a loss in faith of management, there being no viable business to restructure, and the erosion of equity due to the priority DIP Financing and administration charges.

In the result, the Court issued two concurrent orders: one under the CCAA to provide a single and comprehensive forum for all stakeholders, and another receivership order under the BIA, which allowed for the appointment of a receiver over the various properties subject to mortgages. However, the outcome of the Edgeworth proceedings, which pre-dated the decision in Dondeb, was not as effective or efficient as initially envisioned. This result may have weighed in the Court's treatment of Dondeb and may signal the Court's total reluctance to grant CCAA relief to real estate development and investment companies going forward where their assets are in separate entities and independently secured by different mortgages.

Conclusion

Although attractive for its flexibility, the CCAA is not for everyone or every circumstance. Debtor corporations that have disparate real estate development and investment properties in different entities and are encumbered by first-ranking mortgages from several lenders will have difficulty proposing a Plan that is more advantageous than the remedies available to the mortgagees under their respective security. There is little incentive for these lenders with first-ranking security to agree to a Plan that involves the erosion of their security in favour of priority DIP Financing and administration charges. If a debtor corporation is insolvent and not able to complete the development of its real estate properties without further funding, its mortgage lenders may be in a better position by asserting their respective mortgage remedies rather than letting management remain in control of the failed real estate developments under the CCAA. It seems, however, that the presence of a vast and diverse group of stakeholders may be another pivotal factor in the Court's determination of whether granting relief under the CCAA is appropriate.

Footnotes

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

2 R.S.C. 1985, c. B-3.

3 2012 ONSC 6087.

4 Romspen Investment Corp. v. Edgeworth Properties, et. al., 10 November 2011, CV-11-9452-00CL, Receivership Order of Justice Campbell (Ont. Sup. Ct. [Comm. List.]).

5 Re Edgeworth Properties Inc., et. al., 10 November 2011, CV-11- 9409-00CL, CCAA Order of Justice Campbell (Ont. Sup. Ct. [Comm. List.]).

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.