Indalex: Uncertainty Remains over Priority of Pension Shortfalls in CCAA Proceedings
Early in 2013, the Supreme Court of Canada (SCC) released its decision in Sun Indalex Finance, LLC v. United Steelworkers. The upshot of the landmark ruling is that pension shortfalls under Ontario’s Pension Benefits Act (PBA) may rank ahead of secured creditors’ claims in Companies’ Creditors Arrangement Act (CCAA) proceedings. They cannot, however, supersede super-priority debtor-in-possession (DIP) loans.
“The key question was what happens when an employer is winding up a pension plan and having trouble finding the money to do so?” says Ari Kaplan of Toronto’s Koskie Minsky LLP, whose partner Andrew Hatnay argued the case for the main group of creditor pensioners.
The court ruled that the PBA creates a statutory deemed trust that covers not only contributions paid and due to the date of the wind-up, but any deficiency in wind-up benefits.
“The deemed trust provision is a remedial one,” the majority wrote. “Its purpose is to protect the interests of plan members. This purpose militates against adopting the limited scope proposed by Indalex [the debtor] and some of the interveners. In the case of competing priorities between creditors, the remedial purpose favors an approach that includes all wind-up payments in the value of the deemed trust in order to achieve a broad protection.”
Unfortunately, this aspect of Indalex has given rise to various issues for the lending community.
“The court’s confirmation of the existence of a constructive trust may have significant ramifications for lenders relying on security interests in accounts receivable and inventory because the Ontario Personal Property Security Act expressly makes such interests subordinate to deemed trusts under the PBA,” says James Gage in McCarthy Tétrault LLP’s Toronto office.
And it’s not just Canadian lenders who will be struggling with Indalex. “The decision is highly relevant in the cross-border environment, because almost all of Canada’s big companies borrow money from US lenders,” says Gage’s partner Kevin McElcheran. “So companies with large pension shortfalls could have difficulty getting financing from across the border.”
Although some observers have expressed the view that lenders will adjust to this reality and that it will have only a small impact in terms of loan pricing, Gage does not share that view.
“Some lenders took a very conservative approach in assessing their risk while awaiting the Indalex decision,” Gage says. “Now it’s clear that they’re going to face a priority issue and there is no guarantee that they can reverse that priority as part of a restructuring. So I’m not at all sure the issue is going to go away.”
It’s least likely to go away for US lenders unfamiliar with Canada’s insolvency and restructuring legislation.
“There’s no analogous priority scheme in the US that can affect the ranking of secured creditors,” says Pamela Huff in Blake, Cassels & Graydon LLP’s Toronto office.
As well, because the deemed trust covers not only payments due to the pension fund but also to the shortfall between the value of benefits payable and the assets available to satisfy those benefits, lenders will find it difficult to assess their risk.
“Even when the risk is small, the problem may be a mile deep because deficits can be enormous and extremely difficult to quantify,” Gage says.
Huff is of similar mind.
“It’s not uncommon for a pension claim, especially one relating to a legacy plan that has a deficiency, to be the largest claim in an insolvency or CCAA proceeding,” she says.
What’s not clear is whether Indalex would apply beyond Ontario.
“Other provinces don’t necessarily have the same provision in relation to the creation of a statutory trust for pension benefits,” Huff says.
However that may be, Indalex could extend beyond pension claims. “The decision could affect the priority status of such things as source deductions and various kinds of taxes,” Huff says.
But Indalex did clear the air for DIP lenders.
“We can now tell our lending clients with certainty that we can obtain priority for DIP loans that supersedes pension plan claims,” Huff says.
As the SCC saw it, a judge’s order giving super-priority to the DIP lender amounted to a valid federal order that did not negate the existence of the provincial trust for the pensioners, but subordinated it under the doctrine of paramountcy. The fact that paramountcy had not been invoked in the courts below did not affect the principle.
“In essence, the court said that when a judge acting under the CCAA, a federal statute, makes an order, that order is the equivalent of a federal statutory provision,” Kaplan explains.
Nortel: Cross-Border Joint Trial will Proceed
In June 2013, the Ontario Court for Appeal ruled that the joint cross-border trial that will determine the fate of over C$9 billion of Nortel Networks’ residual assets could proceed as scheduled in January 2014.
At that time, teams of lawyers representing Canadian, US and European creditors will square off in a cross-border joint trial of unprecedented size and complexity aimed at allocating Nortel’s remaining assets among its Canadian, US and European creditors.
“There’s hardly a case of any significance that doesn’t have a cross-border element in it, but what is novel about the proceeding is its magnitude, the number of jurisdictions engaged and the number of claimants,” Huff says. “It’s not that cooperation of this type has failed to occur on other occasions, but there’s nothing that approaches the sheer size of what’s going on in Nortel.”
Justice Geoffrey Morawetz of the Ontario Superior Court of Justice and Judge Kevin Gross of the US Bankruptcy Court for the District of Delaware will preside over the trial pursuant to an Allocation Protocol that sets out the terms of the joint trial.
“You’ll have two courts with independent jurisdiction that will hear the common evidence simultaneously and have to arrive at independent decisions on that evidence,” says Mark Zigler of Toronto’s Koskie Minsky LLP, who represents the Canadian Creditors Committee. “That’s never been done before.”
The Joint Administrators of Nortel Networks UK Ltd. and 24 debtors from around the world had appealed from the Allocation Protocol order. They told the Court of Appeal that the joint trial was “a violation of the Ontario court’s independence and sovereignty and will be fraught with irresolvable procedural and substantive problems.” Despite four earlier failed attempts at mediation, two with the same mediator, they took the position that a proper approach was further mediation followed by private arbitration if necessary.
But the Court for Appeal denied the applicants leave to appeal from the order mandating a joint trial. The court ruled that the protocol did not infringe the Superior court’s independence and sovereignty.
“Cooperation and communication between the two courts in accordance with the relevant protocols is not inconsistent with judicial independence, but rather is a sensible and effective response to a significant interjurisdictional commercial case,” the court wrote.
Also salient was the fact that “the majority of the key stakeholders” were prepared to proceed with the joint trial. “Granting leave to appeal would impose additional costs and threaten further delay in proceedings that have already experienced too much of both,” the court stated.
Estimates of the legal costs so far range from C$755 million to C$861 million. But there’s a great deal at stake. Following the surprisingly successful sale of Nortel’s intellectual property, the company and its subsidiaries were left with approximately $9 billion now being held in an escrow account. The difficulty is that there is C$12 billion in outstanding claims: Canadian creditors seek C$4.5 billion, the Americans are looking for C$3 billion and the Europeans are claiming up to C$10 billion.
The four failed mediations are an indication of just how entrenched the parties are in their positions and how hard this case will be fought. As if the multi-party nature of the proceedings and the complexity of the substantive and procedural issues did not make the prospect of a trial sufficiently daunting, the clash of law, procedure, advocacy styles and culture suggest that only disciplined and firm judicial oversight will avoid scenarios approaching chaos.
“It’s going to be very difficult to manage the different cultures, the different sets of laws and the relevant conflicts laws,” McElcheran says.
US pleadings, for example, routinely include references to the law and legal argument, while Canadian pleadings tend to stick to the facts. Canadian lawyers are accustomed to amending their pleadings with regularity and often a minimum of fuss, while Americans take a more aggressive approach in opposing changes.
“So your first shot at the pleadings had better be your best shot,” says one lawyer close to the case.
At a joint hearing earlier this year, other difficulties were manifest. There were significant issues over what needs to be disclosed on discovery because the approaches are so different. American practice, for example, includes depositions from third parties and witnesses, a practice that is the exception rather than the rule in Canada. Indeed, by press time a protective order addressing the difference in rules relating to privilege and confidentiality had already issued.
Arguably, the differences in pleading and discovery rules are only the beginning. For example, admissibility of evidence questions will surely arise at trial, and since each judge is in theory at least making independent decisions, the two courts could come up with conflicting rulings.
But the clash of culture isn’t just legal in nature. A review of the pleadings indicates that national pride is an integral component of the arguments advanced on the merits.
The Canadians are relying on a legal doctrine known as “substantive consolidation,” an equitable remedy that consolidates the assets of all the companies involved, wherever located, and without regard to intra-corporate relationships. Counsel are expected to emphasize that Nortel was a true Canadian success story, the entity that funded the research and development behind the patents that were the heart of the company’s success and that generated C$4.5 billion of the C$9 billion in play. The rest came from the sale of Nortel’s four primary lines of business and of residual assets around the world.
The Americans are honing in on the fact that Nortel generated most of its revenue in the US.
“The Americans are internally focused and both they and the Europeans have a bit of a nose-up, ‘it’s just Canada’ attitude, that is reflective of their cultures,” says a lawyer familiar with the case.
The Europeans’ take includes allusions to North American-based corporate wrongdoing. “There’s even been talk regarding allegations of shadow directors out to exploit Europe,” one observer says.
Still, counsel on the case remain hopeful.
“There’s no doubt that this case has unique aspects and challenges, but they will be overcome by coordination between the two jurisdictions and the application of the various cross-border protocols governing the case,” says Benjamin Zarnett of Toronto’s Goodmans LLP, who represents the monitor, Ernst & Young.
So far, Zarnett’s optimism seems justified. The lawyers involved report that the two courts have worked well and cooperatively on procedural matters to date.
Marciano: Huge US Jury Awards do not Bar Canadian Recognition of US Bankruptcy
The Québec Court of Appeal has ruled that a US bankruptcy judgment based on US jury awards that may be excessive by Canadian standards should nonetheless be recognized by Canadian courts.
Georges Marciano, the founder of the Guess? retail fashion chain, had argued that jury awards of $360 million, mostly for emotional distress, reputational harm, hurt feelings and punitive damages that formed the basis of a US bankruptcy order against him, should not be recognized by Canadian courts on the grounds that it offended public policy contrary to s. 284 of the Bankruptcy and Insolvency Act.
A Québec Superior Court judge agreed, but the Court of Appeal reversed the decision.
“Although the Court of Appeal recognized that judgments of this magnitude were well beyond what Canadian courts would award, that by itself did not lead to the conclusion that they offended public policy,” says Martin Desrosiers in Osler, Hoskin & Harcourt LLP’s Montréal office, who represented PricewaterhouseCoopers in the case. “The court recognized that the international comity requires that the public policy exception be narrowly interpreted.”