Restructuring in a challenging economy

Lawyers expect insolvencies to rise in 2021, along with the use of reverse vesting orders

Canadian insolvency filings reportedly hit a 20-year low in 2020 — but those figures may not tell the whole story.

“That’s what the data is suggesting, and I think that is very counterintuitive,” says Robert Thornton, an insolvency partner at Thornton Grout Finnigan LLP in Toronto. “I think what is going on in the economy is that the government’s support programs [during the COVID-19 pandemic] are working, maybe even a little too vigorously, and that that is depressing the number of filings that we’re seeing.”

The pandemic’s impact on the economy — and insolvencies — has yet to be played out. It will also take time to see the full effects.

At some point, says Thornton, government programs supporting businesses affected by the pandemic are going to stop or be reduced, which will cause an increase in the number of corporate insolvencies.

Also, he says, “I think there is a buildup of cases happening now, in 2021, and I’m starting to see quite a bit more activity on the restructuring front, including . . .  judicial availability on the commercial lists across the country starting to get a little tighter. So, I think it’s becoming busier.”

Businesses that received government loans will need to repay them eventually, resulting in more insolvencies.

But while consumer filings, bankruptcy filings and proposal filings were down, filings under the Companies’ Creditors Arrangement Act and court-appointed receiverships were up last year, says David Bish, head of Torys LLP’s corporate restructuring and advisory practice and a member of the firm’s finance committee.

The decline in filings for smaller businesses is partly due to government support of small businesses and individuals during the pandemic, he says. Still, many smaller companies that have failed haven’t made insolvency filings but have just closed their doors. When pandemic restrictions killed their businesses, “they literally just turned out the lights, and they locked up and left.”

Failures of small businesses such as Toronto’s Prairie Girl bakery, which specialized in cupcakes and shuttered its business permanently in January, are examples of companies that have failed but without insolvency filings, he notes. Prairie Girl joined a long list of restaurants, cafés and bakeries that closed in 2020 and 2021 due to pandemic restrictions, although those failures haven’t registered on the insolvency charts.

Large restructurings were active in 2020, says Robert Chadwick, a Goodmans LLP partner in Toronto, with companies completing their restructurings under the CCAA and the Canada Business Corporations Act. The energy and oil and gas sectors were active. Bonavista Energy, Calfrac Well Services, Source Energy, Just Energy, Bellatrix Exploration and Delphi Energy all completed significant recapitalization transactions last year, says Chadwick.

Sherritt International, Nemaska Lithium and Dominion Diamond also completed major restructuring transactions in mining. Comark Inc., Hertz Corp. and Cirque du Soleil completed major transactions in the retail and consumer areas. The cannabis sector also saw several restructurings and transfers of business operations to new owners. There were also more appeals in restructuring transactions, Chadwick notes.

“We see 2021 developing more over time, as the credit markets are open and there is significant liquidity available for companies from a variety of sources,” he adds. “Lack of revenue and earnings and high debt levels will defer some situations into mid-to-late 2021.”

Reverse vesting orders

Using reverse vesting orders to acquire distressed businesses and assets was a notable trend in 2020. Although not new, they have become the “flavour du jour,” says Kelly Bourassa, a partner at Blake Cassels & Graydon LLP in Calgary.

Reverse vesting orders allow liabilities to be transferred out of the target company so that the purchaser may acquire a “clean” company without a plan of arrangement or creditor vote. The non-assumed liabilities are vested in newly incorporated non-operating companies as part of a pre-closing reorganization. RVOs are being used more and more, especially in regulated industries such as cannabis.

RVOs are permitted under the CCAA, particularly where such transactions allow an internal reorganization that is fair to affected stakeholders’ interests, and there is no prejudice to the applicants’ major creditors.

Bourassa recalls the first RVO was a CCAA proceeding in 1999 concerning Eaton’s, the national department store chain that shut its doors that year. The Plasco Energy Group bankruptcy filing in 2015 also used an RVO, “but, really, 2020 was a watershed for RVOs,” she says.

(Thornton remembers getting his first RVO from Justice Jack Ground of the Ontario Superior Court of Justice 20 or 25 years ago and that the judge questioned him at length. “I convinced [the judge] that, in an ordinary asset sale transaction, the purchase price went to the liabilities and that we were doing exactly the same thing here but we were preserving the corporate structure, which had licences and tax attributes that were necessary for the purchase to go through.”)

Two notable and contested RVOs in 2020 were Quest University Canada (Re) and Arrangement relatif à Nemaska Lithium inc. Nemaska Lithium is a public mining company to which an RVO was granted in October and upheld by the Court of Appeal for Quebec in November. Quest University was granted an RVO in December.

Quest University obtained protection under the CCAA in January 2020. It had a creditor who would otherwise have had veto power over a plan of arrangement and opposed an RVO that would have transferred Quest’s obligations under its property subleases to a wholly owned subsidiary formed for this purpose. In granting Quest the RVO, Justice Shelley Fitzpatrick of the British Columbia Supreme Court relied on several recent authorities from Quebec and Ontario and found no provision in the CCAA prohibiting an RVO structure.

Section 36 of the CCAA allows the court broad discretion to consider and, if appropriate, grant relief. Referring to the Supreme Court of Canada’s decision in 9354-9186 Québec inc. v. Callidus Capital Corp. in May, Fitzpatrick noted that the court must keep in mind three “baseline considerations” that the applicant bears the burden of demonstrating: “(1) that the order sought is appropriate in the circumstances and (2) that the applicant has been acting in good faith and (3) with due diligence.”

The judge used her discretionary powers to approve an alternative transaction, says Bourassa, because it was the only option available to the debtor company, therefore, in the greater stakeholder group’s best interests.

Torys’ Bish acted for the purchaser in Nemaska, a complex case in which an alleged creditor and some shareholders opposed approval of an offer Nemaska had received while seeking CCAA protection. The trial testimony took seven days. And although the Quebec appellate court’s denial of leave to appeal has been appealed to the Supreme Court of Canada, “there was confirmation that the courts have the jurisdiction to permit this tool,” he says.

This confirmation is significant because, historically, insolvency sale transactions have had to be asset sales. For the most part, “you could buy assets, but you couldn’t buy shares,” because buying the shares would mean inheriting “all the liabilities in the company whose shares you had bought.” The only way to do a share deal was through a restructuring plan in which the company was cleansed, at which point the shares could be bought, he says.

Transactions have proceeded for many years as asset deals, in which a lot of value can be lost, Bish says. This loss can happen through tax attributes and risks to an asset deal if, for example, there are licences that need to be assigned (in Nemaska, there were mining licences) and employees need to move to a new company.

Reverse vesting orders allow for more share deals “because it allows you to move the liabilities that you don’t want out of the entity and then buy the shares; it opens up a whole other aspect to sale transactions that really has been foreclosed to us up until now,” he says. “I think people are quite excited about the prospect of it, and I think you’ll see a lot more of those transactions now that we have a green light.”

Green Relief Inc., a cannabis company, was granted an RVO in November. Since Health Canada requires and issues licences for cannabis companies to cultivate, process and sell their products under the Cannabis Act, “it’s been a transaction vehicle of choice in the cannabis sector,” Bish says. The licensing requirements are “very particular,” and it’s difficult to get new ones; with an RVO, a buyer doesn’t require a new licence or even to transfer the existing licence.

And other regulated industries are just as ripe for this kind of transaction, says Bourassa, where a corporate entity with specific attributes needs to be maintained. The alternative if trying to keep a corporate shell, she says, is a plan of arrangement that requires majority creditor approval.

Goodmans’ Chadwick, whose firm has acted in several RVOs, including for Plasco Energy, anticipates that RVOs will use will increase. But, he cautions, “courts must balance prejudice to stakeholders. It’s not a replacement of a plan of arrangement.”