Art of the Case: Target Canada's Restructuring
Target Canada may be gone, but its quick and orderly exit through a complex restructuring serves as a primer for American chains in Canada
Confrontation to collaboration to unanimity. Bitter public backlash to creditor consensus. Reputational risk to effective damage control. These are the hallmarks of Target Canada Co.’s restructuring, representing a 16-month-long swing of the pendulum in a proceeding that could otherwise have culminated in years of litigation and uncertainty for small and large creditors alike — not to mention a bigger black eye for the Target brand, already diminished by the well-documented litany of unpreparedness and poor judgment culminating in a debacle that included what was then the largest mass termination of employees in Canada.
On January 15, 2015, Target Canada announced that Ontario Superior Court Justice Geoffrey Morawetz had granted it creditor protection under the Companies’ Creditors Arrangement Act. The Canadian operation had averaged $200 million in losses in each quarter of its existence. It had liabilities exceeding $5 billion.
Within three months, Target had shuttered 133 stores in Canada. It was a stunning demise to the US chain’s first international foray, ever so far removed from its expectation of profitability within its first year of operations. The end came just four years after the parent company, Target Corp., spent $1.8 billion to purchase the leases of the defunct Zellers chain as part of its $7-billion investment in Canada.
In February 2015, the court approved an inventory and real estate liquidation and sale process that was substantially concluded by the fall. The parties then undertook a claims process and Target Canada began to develop a plan that would distribute the proceeds and complete an orderly winding-down of the business.
But closing the stores and selling the assets proved far simpler than winding down and leaving. “It’s important to understand the complexity involved in this restructuring,” says Tracy Sandler, a member of Target Canada’s legal team at Osler, Hoskin & Harcourt LLP in Toronto. “It was the most challenging mandate of my 25-year career.”
To begin with, Target’s insolvency was the first of a major anchor tenant since that of the T. Eaton Company in 1999. But Target had more than twice as many stores as Eaton’s did. “We were in unheard-of territory, largely because the premises were so huge,” says Linda Galessiere of McLean & Kerr LLP in Toronto, who acted for a significant group of independent landlords.
The 133 stores ranged in size from 80,000 to 125,000 square feet. There were four unopened stores, three huge distribution facilities, three owned distribution centres, a leased headquarters building, 10 office suites and six warehouse facilities. “Each retail location could probably have sustained a CCAA proceeding on its own,” Sandler says.
Many of the locations also had unique issues attached to them, including those emanating from differences in provincial law. Some of the landlords had guarantees from the parent and some didn’t. While the economic interests of the various landlords were in many cases discrete in other ways as well, consensus was ultimately required to present a common front in the proceeding.
“It was a miracle that 100 per cent of the landlords ultimately signed on to the de facto group,” says one landlord’s counsel. “We really pulled a rabbit out of the hat.”
Suppliers also came in different shapes and sizes: some from Canada, some from the US, some from abroad, some who had ongoing relationships with Target US and some who did not. As well, Target employed about 17,600 employees in Canada, all of whom were terminated together with 800 in the US who were working on the Canadian operation.
Then there were the stores within the stores, including kiosks, pharmacies, food markets and Starbucks. When Justice Morawetz made his initial protection order, goods were in the outlets, in inventory, in transit and on the dock. There were issues relating to such diverse matters as signage, refrigeration systems and regulatory concerns regarding controlled drugs in the possession of 110 shuttered pharmacies.
“Arguably, the pharmacists were the most affected group,” says William Sasso of Sutts, Strosberg LLP in Windsor, Ont., who represented them. “Target set up programs and compensation funds for their own employees, many of the suppliers had the leverage that came from ongoing dealings and relationships with Target US, and many of the landlords had guarantees from the parents.”
The pharmacists, who as professionals were stuck with legal responsibilities as well as financial consequences, found themselves on the wrong end of the stick.
“Target wasn’t going to accept any responsibilities for shutdown costs or payments discontinued under various franchise programs,” Sasso says. “There was no offer to buy back assets or provide financial relief. Instead, the pharmacists were told they alone were responsible for shutdown costs and for their own employees and contractors. Then Target cut off communications. I’m not even quite sure I heard anyone saying ‘good luck.’”
Ultimately, however, the negotiations and outcome turned on three pivotal issues: the status of Target’s intercompany debt claims; the status of guarantees that Target US had signed in support of 75 leases; and suppliers’ “30 Day Goods” claims, those involving inventory that could be repossessed under the Bankruptcy and Insolvency Act, but not under the Companies’ Creditors Arrangement Act, by unpaid suppliers if they had been delivered within 30 days of the bankruptcy.
Remarkably, all was substantially resolved in less than 16 months from the original filing. The scenario was one that had seemed unlikely even four months earlier in January 2016 when Justice Morawetz, in a rare ruling, refused to send an initial restructuring plan put forward by Target Canada to a creditor vote. This despite the fact that the Monitor, Alvarez & Marsal Canada, and its counsel, a team from Goodmans LLP in Toronto led by Jay Carfagnini, supported the motion.
But in May 2016, Justice Morawetz sent a new plan from Target to the creditors. It provided for subordination of the intercompany debt and a release of Target US’s lease guarantees. Unsecured creditors received between 66 and 77 per cent of what they were owed, an almost unheard-of result. The vote in favour was unanimous. At press time, the distribution of funds was to begin in early July.
As it turns out, Target Canada could simply have gone bankrupt under the Bankruptcy and Insolvency Act. According to Sandler, Target US preferred this route, at least initially.
“The parent company would have been very prepared to have this go into a bankruptcy because the recovery for them would be so much better,” Sandler says. “They wouldn’t have subordinated the intercompany debt and that would have funded the guarantee litigation, which raised some real issues.”
But Sandler says there were many reasons for choosing the CCAA. “Our mandate from Target Canada was for speed, certainty and a graceful exit,” she says. “It was critical for us to come up with a creative solution for the human side of the equation relating to employees and team members.”
Early on, Target signalled that the company intended to do the right thing — at least for its employees. As part of its CCAA filing, it set up a $70-million trust fund to ensure that employees received at least 16 weeks of working notice or termination. Normally, such claims can be compromised by the priority rights of bondholders and others.
In other words, brand reputation mattered. “Bankruptcy was not a possibility that we found palatable,” Sandler says.
Indeed, going the BIA route, in which the guarantee and possibly other litigation could have dragged on for years after the formal BIA proceedings concluded, might only have prolonged Target’s Canadian death spiral in the public eye. There’s little doubt that a continuing saga featuring the $70-billion Target enterprise against smaller Canadian entities would have been excellent grist for the media mill. “There was definitely something in the optics of an out-and-out bankruptcy that made Target uncomfortable,” Galessiere says.
Jay Swartz, who with colleague Robin Schwill of Davies Ward Phillips & Vineberg LLP in Toronto, led the team representing Target US, agrees that his client would have achieved a better recovery in a pure liquidation. “Otherwise, Target Corp. was indifferent as between a bankruptcy and a CCAA restructuring,” he says.
To the extent that the views and interests of Target US and Target Canada diverged, corporate governance became an important issue for the Osler team.
According to Sandler, “The relationship between the parent and its subsidiary, especially the question of the intercompany debt, overlay a dynamic that was very important to us. Target Canada had its own CEO, management and corporate governance, all of which had to be acknowledged in the negotiations, which invariably involved the parent.”
Still, Sandler insists that the Canadian and American operations were for the most part on the same page. “Nobody was afraid to litigate,” she says.
However that may be, many of the creditors’ lawyers were skeptical, to say the least, of Target Canada’s motive for choosing the CCAA.
“There was no pretense that the company might survive or that there might be a going-concern purchaser that would allow the business to continue in some form,” says David Bish of Torys LLP in Toronto, who represented Cadillac Fairview Corporation Limited, a large landlord. “From the get-go, landlords were cynical, believing that Target was using the CCAA to get around the guarantees.”
Unlike the BIA, the CCAA gives judges broad discretion to grant releases, including third-party release, where to do so is in the interests of creditors as a whole. During Canada’s asset-backed commercial paper (ABCP) crisis, for example, the court granted some very broad releases. Although the releases were widely criticized, they stood up on appeal.
“Generally speaking, that kind of discretion isn’t available in bankruptcy proceedings, where there would be no issue about staying the guarantees,” Bish says. “There are also a whole lot of rules in the BIA that aren’t in the CCAA, which avoids a lot of disputes because we have clear law.”
But Sandler contends that the strictures of the BIA would have created a much more drawn-out and costlier process. “If this had been a bankruptcy, there would have been no subordination,” Sandler says. “Instead, we’d have had a liquidation followed by ongoing, costly litigation over the landlord guarantees and the 30-day goods that would have depleted the amount of the recovery available from the liquidation.
Indeed, Galessiere maintains that the desire of Target US to avoid further litigation was a driving force in the decision to proceed under the CCAA. “There’s no way the parent wanted to be stuck with 75 lawsuits in Canada after the insolvency was resolved and they were otherwise out of Canada,” she says.
According to Richard Orzy of Bennett Jones LLP in Toronto, who represented RioCan Real Estate Investment Trust, the landlord with the largest economic stake in the proceedings, the release of the guarantees remained at the core of Target’s negotiating tactics throughout.
“We knew full well what Target was trying to do,” Orzy says. “What often happens is that the parent kicks in money it doesn’t have to contribute on condition that the guarantees will be released in the hope that the judge will agree that this is in the interest of all creditors.”
As it turns out, that’s exactly what occurred. The final plan provided for Target’s release of its intercompany debt, while the landlords gave up resort to the guarantees. Most unsecured creditors and employees, meanwhile, had little cause for complaint.
But consensus didn’t ome easily. Good will, after all, was in short supply when Target announced its closure. Resentment rose as it became evident that mismanagement had loomed large in the retailer’s failure.
“People were asking themselves, ‘Who makes a decision to open 126 stores [seven were unopened] without having a proper distribution network up and running and then leaves without giving the enterprise a chance?’” says one lawyer close to the case. “There was a great deal of bitterness among many stakeholders who saw Target as yet another big American bully.”
To this day, the bitterness lingers. So much so that many involved in the restructuring credit the Monitor, and not Target Canada, with convincing the parent company that setting up a trust fund for employees was the right thing to do.
There’s probably something to that. “The conscience of the debtor is the monitor,” says Sandler.
But it’s also true that Target US agreed to subordinate some $3.5 billion of its $5 billion-intercompany debt as part of its CCAA filing. Swartz attributes much of the success of the CCAA process to this. “Everyone did so well because Target Corp. was prepared to subordinate a significant amount of debt at the very beginning,” Swartz says. “Otherwise the recoveries, especially those of the unsecured creditors, would have been less than half what they eventually got.”
The subordination, however, came with a heavy price for landlords. Justice Morawetz’s initial ex parte order stayed any action enforcing the guarantees against Target USA.
Bish says the CCAA doesn’t allow such a stay. “Target simply asked the court to ignore the statute, which says that guarantees of this kind can’t be stayed,” he says. “How the court could ignore that was never explained. Justice Morawetz simply said that he was satisfied that he had jurisdiction.”
Within a month, the landlords and their counsel had organized a de facto steering committee. Getting them organized, however, wasn’t an easy task. Some 15 law firms were involved in representing landlords. Some lawyers, including Bish (Cadillac Fairview), Orzy (RioCan) and Matthew Gottlieb of Lax O’Sullivan Lisus Gottlieb LLP in Toronto (KingSett Capital), represented individual clients. Galessiere, however, represented some 15 Target locations through three management companies and about a half-dozen individual landlords.
When the concerns about the stay of the guarantees emerged, Target called a meeting of all the landlords’ counsel. But Target must have known that its position on the ex parte stay of guarantees was fairly weak. Conversely, the landlords’ counsel must have felt strongly that they were on the right side of the law.
So much so that by the meeting’s end, Target had agreed to add what became known as “Paragraph 19A” to an amended original order. It provided that the claims of any landlord against Target relating to any lease of real property would not be determined in the CCAA proceeding or affected in any way by any plan filed.
“The speed and breadth of the landlords’ drive to organize and speak with one voice surprised Target a bit and was fundamental to achieving the amendment,” Bish says. “It’s something that could not have been done much later because at that point the horse would have left the barn.”
In return for the insertion of 19A, the landlords agreed to withdraw their opposition to the CCAA process and to refrain from pursuing proceedings in bankruptcy.
As it turned out, the insertion of Clause 19A wasn’t the only development that restored the balance of power as between Target and its creditors. Both the trade creditors and the pharmacists got organized fairly early on.
The trade creditors coalesced largely through the efforts of Lou Brzezinski of Blaney McMurtry LLP in Toronto, who resorted to a unique strategy of engagement with Target’s suppliers through social media, providing timely and reliable information by way of a dedicated website, a blog and several podcasts.
Brzezinski teamed with Melvyn Solmon of Solmon Rothbart in the Toronto office of Goodman LLP, who also represented various trade creditors. The two lawyers convinced Justice Morawetz to allow them to investigate the events that led up to the insolvency. In particular, they were looking for information about Target’s foreknowledge of the insolvency and its practices with regard to inventory, particularly 30-day goods. Justice Morawetz also allowed cross-examination of a Target representative with respect to these issues.
As it turned out, neither the documentation nor the cross-examination, which took place in August 2015, yielded solid evidence of wrongdoing on Target’s part. But it did turn out to be embarrassing for the company.
“The witness that Target put forward knew nothing, saying that his evidence basically represented what he had been told,” Galessiere says. “But somebody had to know what was going on and they had to have had an exit plan.”
Justice Morawetz went so far as to chide the company in court, saying he expected cooperation from the debtor. That, Brzezinski believes, was a turning point. “Within a week Target said they wanted to settle and showed me a proposed term sheet that subordinated the remainder of their intercompany claim,” he says. “The suppliers and their counsel, who had been treated as fringe players, suddenly became insiders working together with everyone else to strike a deal.”
It looked like a collaborative effort to settle was in the making.
It was not. While an effort was indeed in the making, it was hardly collaborative.
In late November, RioCan announced that it had reached a separate settlement with Target US. In return for a payment of $132 million, RioCan would release Target from the guarantees it had given with respect to 18 of RioCan’s 26 leases.
By then, Target had also settled with Oxford Properties Group Inc. and Ivanhoe Cambridge, which held 11 leases, and with Cadillac Fairview, which held five. “The RioCan deal was a very important dynamic, a bit of divide and conquer,” according to Galessiere. “Once it had taken care of the largest landlords, Target thought it could push the remaining landlords around.”
There’s no doubt Target was emboldened. Four days after RioCan announced its settlement, Target moved for acceptance of a “Joint Plan Compromise” and asked that Justice Morawetz set a date for a creditors’ vote on the plan’s acceptance. A favourable vote would then have sent the process back to Justice Morawetz for court approval at a “sanction hearing.”
As constructed, the Plan was intended to appeal to “affected creditors” by giving them between 75 and 85 cents on the dollar. But it did so at the expense of landlords with guarantees: it included a term releasing the lease guarantee claims, thereby effectively revoking Paragraph 19A of Justice Morawetz’s amended initial order, which clearly stated that landlords’ lease claims would not be affected by the CCAA proceeding or by any plan filed.
The Plan also breached the Claims Procedure Order, changing the basis on which landlord claims were to be quantified. “The Plan was generally unfair to landlords because it removed landlords from the claim process and valued all their claims equally, regardless of the location of the premises or the prospects for and costs of re-renting,” Galessiere says.
By all accounts, this was the first time a company under CCAA protection had reneged on a deal with creditors. “The landlords who had guarantees were outraged because they had bargained for their survival,” Sandler confesses.
What appeared to outrage the landlords even more was the Monitor’s apparent support of Target’s Plan. “The court-appointed Monitor’s acceptance of the plan that breached a court order was staggering, and it shocked a lot of people,” one lawyer says.
Galessiere, for one, was distraught at the Monitor’s position. “Paragraph 19A needed to be upheld because so much goes on outside the courtroom in a CCAA proceedings,” she says. “For the process to work, negotiated terms incorporated in an order have to be respected to the same extent as adjudicated provisions.”
Some landlords’ counsel say the repudiation of 19A was perhaps the inevitable result of a simmering pot that boiled over. “Of all the files I’ve been on, this was the worst relationship that creditors have ever had with the Monitor,” says one CCAA veteran. “We never felt that the Monitor was giving the creditors a fair shake.”
Swartz disagrees. “The Monitor worked very hard at pushing back at Target Corp. as to the degree to which it would contribute to the Plan.”
For his part, Carfagnini is unapologetic. He maintains that critics have mischaracterized the Monitor’s position. “We were keenly alive to the issues around 19A,” he says. “In the end, we did not support or oppose the Plan, rather at that point we supported the creditors voting on it since things had changed since they had first negotiated 19A — the parent had agreed to subordinate its claims.”
Carfagnini goes on to explain that the process allows the Monitor to comment further on the Plan after the vote and before the sanction hearing. “If the creditors supported the Plan, the time to deal with 19A was at the sanction hearing, when objections could be raised and Justice Morawetz would have to decide whether to give court approval,” he says.
Criticism of monitors and their counsel in CCAA proceedings are not uncommon, Carfagnini adds, because their roles are often misunderstood. “There is no functional equivalent for CCAA monitors in Canada or the US,” he says. “They are not trustees in bankruptcy whose job it is to represent the creditors. They are officers of the court who represent all the stakeholders. As such, they have wide powers to oversee and direct the process, with the ultimate goal of getting an acceptable plan approved pursuant to the will of the majority.”
That, Carfagnini maintains, is exactly what the Monitor in this case was trying to do by advancing the Plan to a creditors’ vote. “We attempted to balance everyone’s interests, including keeping alive a process that allowed the subordination of Target’s intercompany debt to remain in place and for all the creditors to have the right to vote on the Plan,” he says. “It’s a bit hollow for certain landlords who held parent guarantees of their entire claims to be critical when they were not at risk and especially when the process ultimately worked to their advantage.”
It’s an open question, however, whether the process would have worked quite as well to the landlords’ advantage had they not opposed the Plan’s filing, a move that ultimately resulted in a ruling from Justice Morawetz in January 2016 denying leave to send the Plan to a vote.
“Simply put, I am of the view that this Plan does not have even a reasonable chance of success, as it could not, in this form, be sanctioned,” Justice Morawetz stated in his reasons.
Justice Morawetz eviscerated Target’s position. “In my view, there was never any doubt that Target Canada and Target Corporation were aware of the implications of paragraph 19A and by proposing this Plan, Target Canada and Target Corporation seek to override the provisions of paragraph 19A,” he wrote. “They ask the court to let them back out of their binding agreement after having received the benefit of performance by the landlords. They ask the court to let them try to compromise the Landlord Guarantee Claims against Target Corporation after promising not to do that very thing in these proceedings. They ask the court to let them eliminate a court order to which they consented without proving that they have any grounds to rescind the order. In my view, it is simply not appropriate to proceed with the Plan that requires such an alteration.”
Target’s argument, moreover, that the guarantee issue, among others, could be debated at the sanction hearing was not an attractive alternative because “it merely postpones the inevitable result, namely the conclusion that this Plan contravenes court orders and cannot be considered to be fair and reasonable in its treatment of the Objecting Landlords.”
Insolvency lawyers say it’s rare for a court to reject a course of action supported by the monitor. “The general theory is that the monitor gets its way,” says one lawyer.
The press didn’t do Target any favours either. “Court rules Target Canada tried to use insolvency laws to avoid landlord losses,” screamed one headline from The Globe and Mail.
Strategically, then, the landlords had scored big. “The leverage dynamics certainly changed at that point,” Sandler says. “But they also reinvigorated us and led us to push harder for a commercially reasonable resolution.”
Less than two months after Justice Morawetz’s reasons were released, the landlords and Target settled. “One of the remarkable things about this was getting all the landlords, many of whom were in different economic positions, to agree to a deal outside of the court process,” Swartz says.
Galessiere’s contribution, it appears, was key. “Linda made a Herculean effort by leading the charge to build consensus among the landlords,” Sandler says. “There was a huge risk in doing that but she was prepared to take it.”
The unsecured creditors also gave ground. In the final analysis, they accepted about 10 cents less on the dollar than the first Plan would have given them. Their compromise left more money available for the landlords and contributed significantly to consensus, particularly the agreement of those with guarantees.
The messy claims of the pharmacists also took shape with Sasso’s formal appointment as their representative counsel to represent their interests in connection with the Claims Process, one ultimately adjudicated by Dennis O’Connor, former Associate Chief Justice of Ontario.
At the creditors’ meeting on May 25, 2016, 1,264 creditors representing more than $550 million in claims voted unanimously in favour of the Plan. On June 2, Justice Morawetz gave court approval at a sanction hearing. He praised the result and the parties. At press time, Plan implementation and fund distribution was to commence in late June.
Target is, for all intents and purposes, gone from the Canadian landscape. But the spectre of its failure isn’t gone, serving as a precautionary note to the growing number of American chains that seek to do business in Canada and to those with whom they will be dealing.
Clearly the new ventures won’t all succeed. But hopefully Target’s orderly and relatively swift retreat through the CCAA maze will provide some guidance for those that do not, as well as their employees, landlords, suppliers and other creditors.
Julius Melnitzer is a freelance legal-affairs writer in Toronto.