Equitable subordination clarified

Court rules that equitable subordination can only be applied under the language of the CCAA
The U.S. Steel Canada plant in Hamilton, Ontario, now closed. (REUTERS/ Mike Cassese)
The U.S. Steel Canada plant in Hamilton, Ontario, now closed. (REUTERS/ Mike Cassese)

IN ITS SEPTEMBER DECISION in Re: US Steel Canada Inc., the Ontario Court of Appeal appears to have closed the door on claims of equitable subordination in Companies’ Creditors Arrangement Act (CCAA) proceedings.

“What US Steel means is that creditors won’t be able to litigate conduct-based allegations among themselves in CCAA proceedings,” says Michael Barrack of Blake, Cassels & Graydon LLP in Toronto, who led the firm’s team representing United States Steel Corp. (USS).

The doctrine, accepted in the US, would allow for the re-ranking of creditors’ claims where higher-priority creditors engage in inequitable conduct. It’s an important decision for secured creditors generally and for insolvency proceedings for subsidiaries who are in debt to their parents.

But David Bish of Torys LLP in Toronto says equitable subordination may still be available in certain circumstances. He notes, for example, that the OCA focused on the fact that equitable subordination arose here in the context of an inter-creditor dispute.

“The key question for the court was whether applying the doctrine furthered the purposes of the CCAA, which are aimed at assisting debtors in their restructuring,” he says. “Here the fight was among creditors, but what if the debtor had been asking for the court to apply the doctrine?”

US Steel Canada (USSC), formerly known as Stelco, was the Canadian subsidiary of US Steel. After the Ontario Superior Court granted creditor protection in 2014, the parent company, USS, filed a $2.2-billion claim against its subsidiary. Several parties objected to these claims, including a group of former unionized employees, represented by Andrew Hatnay and a team from Koskie Minsky LLP.

Among other things, the employees based their case on allegations of oppression and breach of fiduciary duty regarding USS’s conduct in relation to the Canadian operations and pensioners. They alleged that USS caused USSC to underperform, leading it to incur significant debt and defaulting on its pension obligations.

The employees sought an order subordinating the USS claims to their own.

The CCAA judge refused to apply the doctrine, reasoning that the CCAA and its legislative history restricted its application. The OCA upheld that ruling, but on different grounds.

Indeed, the OCA specifically disagreed that the CCAA restricted the application of equitable subordination.

Rather, the court ruled that equitable subordination (or any other remedy) could only be applied under the language of the statute, which required any order to be “appropriate in the circumstances.” The court’s powers “are shaped by the purpose and scheme of the CCAA,” the court wrote. “The appellant has not identified how equitable subordination would further the remedial purpose of the CCAA.” The court did, however, expressly leave open the application of equitable subordination under the Bankruptcy and Insolvency Act (BIA).

Unlike the CCAA, the court noted, the BIA created a scheme of priorities for distribution. By contrast, the CCAA left these to be worked out largely by negotiation as part of a compromise or arrangement.

“There is no provision in the CCAA equivalent to s. 183 of the BIA or s. 105(a) of the U.S. Bankruptcy Code. Section 183 invests the bankruptcy court with ‘such jurisdiction at law and in equity’ as will enable it to exercise its bankruptcy jurisdiction,” the court stated.

“This is significant, because if equitable subordination is to become a part of Canadian law it would appear that the BIA gives the bankruptcy court explicit jurisdiction as a court of equity to ground such a remedy and a legislative purpose that is more relevant to the potential reordering of priorities.”

For the most part, Canadian courts have taken a liberal approach to debtors’ resort to the CCAA. Whether that continues to be the case when the proceedings resemble a liquidation and equitable subordination is a viable argument remains to be seen.

Regardless, Bish welcomes the OCA’s decision in the case. “Because individual facts are always so important in CCAA proceedings, it’s rare that we see appellate courts going as far as they have in this case in providing parameters for the future.”