The difficult tightrope courts must walk in insolvencies

Many a stakeholder has been stunned by the broad powers of the Companies' Creditors Arrangement Act (CCAA) to stay – and then compromise – nearly all claims against an insolvent company. This power has recently been confirmed to extend even over remediation orders issued by provincial ministries of environment (MOEs), though the issue is now the subject of a second challenge within 12 months before the Supreme Court of Canada.

In short, a court administering CCAA proceedings has the power to bring nearly all claims against an insolvent company into a “single proceeding” under its purview, stay creditors' legal actions, “make any order that it considers appropriate in the circumstances,” disclaim contracts of the debtor company and seek creditors' approval for the “compromise” of debt obligations (CCAA s. 11).

Insolvency specialists agree this judicial discretion is essential if CCAA goals – to restructure and refloat sinking companies – are to be achieved, with all the attendant social benefits of continued employment and potentially higher debt recoveries. Still, a more perfect balance of competing interests continues to be pursued through Canadian courts.

Points of contention currently include environmental remediation orders, pension deficits and the enforcement of technology licences.

“These laws are rubbing up against each other — and it's not a tidy intersection,” says Robert Thornton, a leading Toronto insolvency practitioner with Thornton Grout Finnigan LLP. “It's a very hot topic.”

So hot that counsel for MOEs have suggested the CCAA is in danger of becoming a “regulatory car wash,” arbitrarily cleansing debtors of environmental obligations and leaving taxpayers to pick up the tab. Insolvency specialists have responded that giving priority to huge environmental claims can kill thousands of jobs, blight the retirements of thousands of pensioners, destroy supplier companies and cast a pall over broader financial markets.

Richard Orzy, with the Toronto office of Bennett Jones LLP, insists that precedents undermining the security and confidence of lenders reach far beyond insolvency practice, potentially doing lasting damage to the liquidity of markets and the health of the national economy. “It's also about the companies that never go into insolvency but have needs to borrow money on acceptable terms,” he says.

Canada's “middle-market economy” can't afford the luxury of increasingly lengthy, costly and uncertain insolvency proceedings, says Robert Chadwick with Goodmans LLP in Toronto. “The more certainty there is in restructuring, the better off we'll all be,” he says. That's why CCAA courts “are intended to be command centre for restructuring.”

“Some would say the CCAA is too broad,” he concedes. “I would say it's not.” He says many restructured companies survive to conduct remediation and pay pension obligations. But if trenchant pursuit of such environmental or pension claims results in liquidation, no one benefits.

Sylvain Rigaud, of Norton Rose Fulbright Canada LLP in Montreal, is less categorical. Rigaud says that within insolvency law, “there's a need to look at the broader scope of interests and, at the same time, preserve a single proceeding.”

Conflicting priorities have been cast into sharp relief by the sheer size of recent insolvency cases and related regulatory claims. Pamela Huff of Blake, Cassels and Graydon LLP in Toronto, cites Air Canada, Nortel Networks and AbitibiBowater as examples of big insolvencies with clashing environmental claims.

“These are colossal cases — companies that many would have considered too big to fail,” Huff says. Pitted against the conflicting interests of lenders, suppliers and employees, “we're seeing significant environmental claims that the ministry wants to pursue, rather than having the public pick up the tab,” Huff says. Environment ministries, she says, are seeking to have their remediation orders recognized as “higher obligations that cannot be compromised in CCAA proceedings.”

Thornton bristles at the notion environmental issues should claim a higher priority than commercial considerations. “What people miss in all this,” Thornton says, “is that polluter-pay is no higher or better principle than debtor-pay. They have the same standing in law. Neither should get a free pass through the restructuring process.” And, accordingly, lenders should not have their legally negotiated security trumped by environmental orders.

“The CCAA doesn't make all the rules,” he says. “It sets the table for people to work out solutions. It relies on all parties acting in a commercially sensible way.”

The crunch comes when parties to an insolvency assert a higher standing for conflicting, non-commercial values.

“Nobody disputes that an environmental cleanup is a good thing,” Orzy says. “But if the result of a cleanup order is to shut down an operating business, then I think everybody has to take a step back. The cost of a cleanup may be a lesser burden on society than the loss of a [large] company. It's the good of the many versus the good of the few.”

Few would dispute that the CCAA was created and given sweeping powers to uphold the good of the many. Passed into law in 1933 to mitigate the social carnage of the Depression, it was not until 2010 that its powers were first challenged before the Supreme Court of Canada. In Century Services Inc. v. Canada (Attorney General), the Supreme Court ruled that goods and services taxes collected by the debtor company, LeRoy Trucking, were assets of the company and therefore subject to the claims of its creditors, including Century Services.

With the federal taxman brought firmly to heel, the CCAA might have been assumed to have few remaining challengers. But provincial environment ministries have been willing to try.

They've disputed CCAA court stays of their remediation orders and the relegation of those orders to the position of unsecured claims on the estates of insolvent companies. That issue is now before the Supreme Court for the second time in 12 months. After the top court ruled against the environmental claim asserted by Newfoundland in AbitibiBowater, Nortel Networks on Dec. 2, 2013 sought SCC leave to appeal from a decision of the Ontario Court of Appeal (OCA). In Nortel Networks v. MOE, the Court of Appeal declined to stay big-ticket regulatory orders on four of five properties once owned by Nortel.

“The debate is between those who accuse large corporations of using the insolvency process as a ‘regulatory car wash' to circumvent the application of the ‘polluter-pay principle' … and the insolvency professionals who argue that the very purpose of the insolvency process is to allow the debtor a ‘fresh start' by compromising all of the debtor's liabilities,” lawyers for Abitibi wrote after their Court of Appeal victory (Unstoppable Force Meets Immovable Object: The Supposed Clash Between Environmental Law and Insolvency Law After Abitibibowater; Sean Dunphy, Guy Martel and Joseph Reynaud; Stikeman Elliott LLP).

In both Nortel and Abitibi, provincial environment departments have sought a reaffirmation of the environmental priority expressed by the court in the 1991 Panamericana ruling. In that ruling regarding a well-site reclamation, the Alberta Court of Appeal found a duty was owed to the Alberta public to comply with provincial law “enacted to protect the environment and the health and safety of all citizens.” This public duty is only converted into a financial claim that's subject to compromise under CCAA if and when a regulatory body undertakes remediation, thus implying that it will seek cost recovery from the company, the court said.

Environment departments have generally been careful since then to avoid any quick actions to remediate contaminated land on their own dime lest they be reduced to unsecured-creditor status under CCAA jurisdiction. Seeking the best cleanup at the lowest cost to taxpayers, MOEs have often stalled the enforcement of their own remediation orders.

In the face of this counterintuitive outcome, Parliament intervened with amendments to the CCAA that speak directly to environmental liabilities. In 1997, CCAA amendments [s. 11.8(8) and (9)] gave federal and provincial governments security for the costs of environmental remediation in the form of a super-priority claim on proceeds from the sale of remediated land and adjacent property. At the same time, Parliament clarified that when remediation is undertaken and costs are incurred, the order becomes a “provable claim” and thereby subject to compromise under authority of the CCAA courts, regardless of whether damage occurred before or after the insolvency filing.

Despite this apparent recognition of environmental imperatives, even ardent defenders of the CCAA process admit that, where there's serious contamination to a typical industrial tract, costs of remediation will very often surpass the land value. Security in the form of contaminated property “can be somewhat illusory,” Huff observes.

In such cases, MOEs become unsecured creditors for the outstanding balance of their claims. While insolvency experts are loath to conclude that Parliament was telling provincial MOEs to shut up and sit down, counsel for insolvent companies have frequently cited s. 11.8 (8) as the upper limit on regulatory recoveries.

In 2009, Parliament again amended the Act by explicitly giving the CCAA court power to rule on whether a government is acting in the capacity of a regulator or a creditor and also spelled out the power of the court to stay any regulatory activity that threatens a plan of arrangement.

The amendment further bolstered the CCAA by what it didn't do, says Domenico Magisano of Lerners LLP in Toronto. Parliament had the opportunity to create “carve outs” for pension or environmental claims to supersede lenders' security. The legislators “heard submissions about it but they didn't do it,” he says. Parliament chose, instead, to preserve and extend the reach of the CCAA.

The Abitibibowater case turned on whether provincial remediation orders had become financial claims and therefore subject to compromise under the CCAA. The Supreme Court ruled that remediation orders against Abitibi were, in fact, provable claims subject to the CCAA process priorities. In a 7-2 decision, Justice Deschamps wrote for the majority, outlining a three-part test for provable claims: 1) there must be a debt owed to a creditor; 2) the debt must have been incurred before the insolvency, and 3) it must be possible to attach a monetary value to the debt.

Apparently slamming the door on the provincial tactic of delaying enforcement activities in hopes of avoiding CCAA jurisdiction, Justice Deschamps said that a “contingent claim” under CCAA may be recognized if it is “sufficiently certain” that the regulatory body will ultimately perform the work required under the remediation order. For good measure, she underscored the power of the CCAA court to consider the potential impact of regulatory orders on the insolvency process.

Still, questions persist. Justice Deschamps said that not all regulatory orders are monetary claims subject to CCAA compromise. She noted that there is a constitutional question whether a CCAA court has power to stay provincial orders not advanced to the point of becoming financial claims under CCAA jurisdiction. “[F] uture cases may give courts the opportunity to consider the question … in an appropriate factual context,” she suggested.

Also suggesting room for further argument, one of two dissenting opinions came from Chief Justice Beverley McLachlin. The Chief Justice challenged a fundamental premise of the majority — that if Abitibi didn't remediate, the province would be forced to do it. In her dissenting opinion, the Chief Justice agreed that environmental orders should be recognized as provable claims if it's likely that the government will undertake remediation. But she said this should be a “likelihood approaching certainty.” And she questioned whether CCAA judges are in a position to divine all the political and social considerations weighing on governments making such decisions. “The province retained a number of options, including leaving the sites contaminated, or calling on Abitibi to remediate following its emergence from restructuring,” she wrote. “There is nothing on the record that makes it more probable, much less establishes ‘sufficient certainty' that the Province will opt to do the work itself.”

Rigaud says Abitibi became a “very technical” ruling, bound by a peculiar fact set, most notably provincial expropriation of the lands in question. “There was no discussion of the debt owed to the public” in the form of regulatory compliance and, he says, he hopes a future case will take this question on directly.

Against this backdrop, Nortel has applied to the Supreme Court for leave to appeal the Oct. 3, 2013 ruling of the Ontario Court of Appeal concerning five Ontario properties under MOE remediation orders.

Relying on the SCC Abitibi decision, the Court of Appeal lifted CCAA court stays of remediation orders on four of the five contaminated properties. The court found that the province had taken no action to do the work on these sites itself. Nortel had sold the four properties to new owners years earlier and, under Ontario's Environmental Protection Act, remediation orders may name both current and former property owners. Under these circumstances, the court found no “sufficient certainty” that the province would be forced to undertake remediation. Accordingly, MOE orders were not provable claims subject to compromise under the CCAA. The Court of Appeal directed the remediation orders to current property owners, as well as Nortel — with Nortel's share of costs threatening to deplete assets available to its creditors.

In its SCC appeal application, Nortel argues that it's in the public interest for the Supreme Court of Canada “to make a further ruling on the power of the regulator to act while a stay is in force.” The company contends that the Ontario Court of Appeal ruling demonstrates the potential for perverse results when lower courts attempt to apply the Abitibi decision. Nortel says these include: 1) outcomes inconsistent with the “single proceeding model” that aims to bring all stakeholders into one forum for fair and equitable resolution of their claims; 2) permitting MOEs to manoeuvre for position ahead of secured creditors by delaying remediation; and 3) motivating MOEs “to act in ways that do not serve the policy and principles of environmental law.”

Robert Thornton says there's no doubt the current system for determining provable claims, based on whether MOEs have taken direct action to remediate, leads to government behaviour that could potentially be counterproductive.

“There is potentially a reward for ministries of the environment to do nothing,” he says. “You would hope that the system would reward diligent, as opposed to dilatory, stewardship of the environment.” Indeed, there are multiple examples of ministries taking a do-nothing tack to avoid having their orders compromised in CCAA court proceedings. If they succeed, they stand a chance of escaping CCAA compromise and having the full cost of their remediation orders paid by the insolvent company.

Still, Orzy says, eco-advocates might want to be careful what they wish for if the result of achieving an environmental priority in insolvency is to erode lenders' security.

“If it's just a battle for money between stakeholders … not a lot of people are going to have a lot of sympathy for the banks over the environment,” Orzy concedes. “But when you start to have major changes in how risky it is to make a loan … then you're going to have a smaller economy.

“I've seen it,” he says, recalling that in the early 1990s, lenders were spooked by environmental claims and they began to retrench. “I know they did because I've been in meetings where lenders walked away.” Eventually, he says, lenders and regulators found an uneasy balance.

From the late 1990s until about 2009, Orzy says, there was something like an unspoken détente between MOEs and insolvency lawyers, based on an appreciation of what he calls “commercial realities.”

“There definitely was this time, from the [late] 1990s until very recently, that you couldn't be overzealous and destroy a viable business for the sake of an environmental claim.”

Now, it seems, environmental claims are bigger, neither side wants to take the hit and both are willing to go to court.

James Gage, with McCarthy Tétrault LLP in Toronto, says insolvency lawyers hoped Abitibi would provide clearer definition of when a regulatory order becomes a provable claim.

“We waited with anticipation for some guidance from the Supreme Court,” Gage says, “but the test they came up with may not be a practical one to apply in a restructuring situation.” He offers the example of an insolvent company with solid prospects for re-emergence from CCAA proceedings as a going concern. If the company faces significant remediation orders on land that's not included in future business plans – and if the MOE has deferred action – it may be very unclear whether the CCAA court will find it “sufficiently certain” that the MOE will take on the environmental cleanup and its costs. In such a case, he says, regulatory orders could escape compromise to be pressed upon the restructured company and the entire restructuring process could be placed in serious peril.

In its current form, he says, the CCAA gives courts the power to impose a stay on regulatory orders if restructuring is threatened and if such intervention is not contrary to the public interest. But, as noted by Justice Deschamps in Abitibi, it's still open to question whether a federal CCAA stay in such a case is an unconstitutional intrusion on provincial powers.

Coming out of Abitibi, says Huff at Blake, Cassels and Graydon LLP, “there's a new test to separate regulatory orders from financial claims — but there's no bright line.” The concern now is that “big holes” in Canadian insolvency laws will create uncertainties that undermine both financial markets and the ability of CCAA courts to restructure companies.

“Just like the US, we want a system that works,” she says. But unlike the US, Huff notes, Canada allows a number of exceptions to the first-priority standing of secured creditors. Following the Indalex decision (Feb. 1, 2013), these now include deemed trusts for pension deficits, as well as source deductions for income tax, unemployment insurance and healthcare premiums, she says.

In Indalex, the Supreme Court found that a super-priority granted by the CCAA court for a debtor-in-possession (DIP) loan held priority over a deemed trust for pension deficits. The court ruled that the federal CCAA holds paramountcy over provincial pension legislation. Therefore CCAA-approved DIP loans retain the first-place ranking granted by the CCAA judge, who cited the logic that insolvent companies could never be restructured without such emergency financing.

While the Supreme Court protected post-insolvency DIP lenders, pre-insolvency lenders fared less well. Randal Van de Mosselaer, of Norton Rose in Calgary, notes that in Indalex the court recognized the existence of a deemed trust for pension deficits — by definition awarding pension deficits priority over pre-insolvency lenders. Van de Mosselaer adds that the court found a conflict of interest in the failure of Indalex to consult pension plan members on terms of restructuring that could affect their retirement incomes.

“That gives plan members a seat at the [insolvency] table and a role to play in restructuring negotiations going forward,” he says. With this lever, he says, pension plan members could kill a restructuring agreement. Depending on the calculus of an individual case, “creditors may be better off simply bankrupting the company,” rather than trying to meet pension members' expectations, Van de Mosselaer says.

The Indalex shadow may also extend over environmental cases, some experts say. The federal paramountcy ruling in Indalex might kill attempts by MOEs to assert the primacy of provincial regulatory orders, explains Magisano at Lerners.

“Indalex and Abitibi are both clear indications from the Supreme Court that the paramountcy doctrine still applies in Canada, not only to legislation, but also to federal and provincial regulatory orders,” Magisano says. In the shoes of MOE counsel, he says, “I'd be trying to get out from under that umbrella.”

Magisano says the intersection of environmental and insolvency law shouldn't simply be a question of whether a regulatory order gets monetized and compromised. He says he believes an appeal based on the constitutionally sanctioned powers of the provinces over property and, by extension, commercial transactions, might have the best chance of beating the paramountcy doctrine.

“There should be no question that it [contamination] gets cleaned up. But what are we willing to compromise to ensure the company can carry on?”

Still, he says, if Nortel receives leave to appeal, he thinks the Supreme Court will use it as an opportunity to provide further indicators to CCAA courts as to when and how a regulatory order becomes a provable claim. But he sees no bright line emerging because “there are too many moving parts” in insolvencies and these will continue to require courts to exercise judgment based on the facts of each case.

Also creating tension is the power of companies under CCAA protection to disclaim otherwise valid contracts, including technology licences, says intellectual property lawyer Paul Armitage of Gowling Lafleur Henderson LLP in Vancouver. A 2009 amendment to the CCAA allows licensees to “use” duly licensed “intellectual property,” even if licences granted by an insolvent company are disclaimed during CCAA proceedings and the same rights are resold to third parties. But Armitage says it's unclear whether “intellectual property” referred to in the Act covers copyrights, patents, trademarks and trade secrets and whether “use” allows for sales, imports, reproduction and/or distribution.

“Insolvency lawyers might say all these things are covered” – or not – “but there's no case law,” he explains. In the resulting legal void, Armitage says, IP lawyers are working with the concept that property interests can't be disclaimed under the CCAA. Accordingly, they've examined the possibility that licensees could take a one per cent interest in the licensing company as a way of securing their interests against any eventual insolvency. But he notes that licensors typically don't want to dilute share values and he adds that such agreements are usually only practical between very large contracting parties.

Another avenue potentially open to licensees is taking security in the licensing company, so that the licensee becomes a secured creditor in the event of an insolvency. But, since the licensing company doesn't owe money to the licensee, Armitage says, it's unclear how this security would be viewed by the court.

“The amendments done in 2009 were definitely a step in the right direction … but the exact scope of that protection remains somewhat unclear,” Armitage says. With no current cases likely to decide these questions, he says, no one knows for sure how to structure technology licences to guard against insolvency of the licensor.

All of these issues, Thornton says, call into question both the capacity of CCAA courts to successfully restructure insolvent companies and the far broader ability of lenders to make loans on reasonable terms with solid security.

“It used to be a lender could take a mortgage and be confident he stood in first place,” he says. But, he adds, one lender recently reckoned that his loan held 14th place in a CCAA proceeding. At this point, Thornton asks, “when does the straw break the camel's back and when do the credit markets cease functioning?”

Brian Burton is an energy and legal-affairs writer in Calgary.