This article was written by Tevia Jeffries, John Regush, Jordan Schultz, and Ari Sorek of Dentons Canada LLP.
Insolvency proceedings can have a wide variety of outcomes depending on a myriad of factors, but a fairly common outcome is a “going concern sale”, where part or all of a debtor’s active business is sold. Traditionally, a going concern sale is achieved through one of two processes: (a) an equity sale, in which the shares (or other equity interests) of the debtor entity are sold to a purchaser; or (b) an asset sale, in which title to the underlying assets are conveyed directly to a purchaser.
Whether an equity or asset sale is preferable depends on the nature of the debtor’s business and assets. For example, an equity sale may be preferable where the underlying business has special licenses, leases or rights that cannot easily be conveyed directly. Alternatively, there may be tax benefits to an equity sale.
A key element to any going concern transaction is to deliver the business/assets “free and clear” of unwanted liabilities. Where the debtor entity is insolvent, payment of all liabilities as a closing cost is not an option. Various strategies have been developed to ensure that the business or assets of a debtor may be transferred to a purchaser cleansed of those unwanted liabilities.
Relief and Recovery : the Evolution of Reverse Vesting Orders
In an asset sale, parties will seek a “vesting order”, conveying title to assets free and clear of existing encumbrances. The vesting order will provide that creditors’ claims will attach to the sale proceeds in the same priority as the claims had against the assets conveyed, leaving a purchaser to operate the business free of these claims. Courts frequently grant these orders, and the jurisdiction and legal tests that support the granting of such orders are well established.
In an equity sale, however, the debtor’s liabilities need to be addressed before a purchaser acquires the shares. Traditionally, a process under the Bankruptcy and Insolvency Act (“BIA”) or the Companies’ Creditors Arrangement Act (“CCAA”) was required to cleanse the debtor entity of unwanted liabilities. Creditors would have to vote on a plan or proposal compromising their claims, and if the statutorily mandated majorities of creditors voted in favour, the plan or proposal would be presented to court for approval. This can be a costly process, and creates significant risk if creditors do not ultimately support the transaction.
Over the past two years, another structure has become increasingly popular in CCAA proceedings. In this structure, courts may approve a transaction whereby unwanted liabilities and creditor claims are vested out of the debtor entity and into a new entity, often incorporated for the express purpose of holding these liabilities (“residualco”). The debtor entity may then exit CCAA cleansed of these liabilities, with the shares transferred to a purchaser. This transaction proceeds with no creditor vote, but still with court oversight.
The orders giving effect to this structure are called “reverse vesting orders” or “RVOs”. RVOs have been granted in CCAA proceedings, first in unopposed applications.1 Then, such relief was granted in opposed applications, leading to case law that describes the statutory basis for these orders pursuant to sections 36 and 11 of the CCAA. Section 11 of the CCAA in particular gives the Court broad jurisdiction to grant, “any order that it considers appropriate in the circumstances”, subject to few limitations.2
More recently, RVOs have started appearing in receivership contexts. The statutory framework in receiverships differs from the CCAA context. Namely there is no direct equivalent to section 11 of the CCAA, giving rise to initial questions about the Court’s jurisdiction to grant RVOs in receiverships. Moreover, receivership proceedings generally do not involve the collective participation, or compel the involvement, of all creditors—a hallmark of CCAA proceedings. While the Ontario courts have recently shed light on the matter, it remains to be seen how other jurisdictions, particularly Quebec, will address these questions.
Examples of Reverse Vesting in Receiverships
Pure Global Cannabis Inc.
The Pure Global Cannabis Inc. (“Pure Global”) proceedings involve one of the first instances of use of a reverse vesting order in a receivership. Pure Global and its subsidiaries were engaged in the production, extraction and sale of dried cannabis products in Canada. In March 2020, Pure Global Cannabis and its subsidiaries filed for CCAA protection. One of Pure Global’s subsidiaries, Puresinse Inc. (“PureSinse”), held certain cannabis licenses, including a production and sale license granted by Health Canada under the Cannabis Act and Cannabis Regulations and the Canada Revenue Agency under the Excise Act.
Eventually, a Receiver was appointed over the assets of Pure Global and its subsidiaries. Notably, the Receiver did not take possession or control of any assets for which a permit or license issued in accordance with the Excise Tax Act, Cannabis Act, Cannabis Control Act, Ontario Cannabis Retail Corporation Act, or Cannabis License Act was required.
In the course of the receivership, a two-stage transaction involving an RVO was negotiated. The RVO component followed the usual structure, with incorporation of a “residual company” (“ResidualCo”) that would be added to the receivership proceedings as a debtor and all right, title, and interest in certain excluded assets and liabilities of PureSinse would vest into ResidualCo. PureSinse would then be removed from the receivership proceedings and ResidualCo would distribute assets to creditors.
The Receiver argued that section 243(1)(c) of the BIA and section 101 of the Courts of Justice Act of Ontario (the “Ontario CJA”) provided the Ontario Superior Court of Justice with the jurisdiction to grant an RVO. The Court ultimately accepted this submission and granted the RVO as sought.
The Vert Infrastructure Inc. (“Vert”) proceedings are another example where an RVO-like structure was used in receivership proceedings. Vert was a publicly traded holding company that provided funding, infrastructure and branding to affiliate licensed cannabis and hemp growers and extractors in the United States. The primary assets of Vert were shares in two related companies.
In Vert’s receivership proceedings, a purchaser expressed interest in purchasing Vert, not for its business assets, but rather for the benefit of its public listing status. To effect this transaction, it was proposed that all Vert’s property vest in a trust absolutely, without recourse, and subject to all existing encumbrances. The trustee of the trust (the same entity that served as Receiver) would administer the property in the same manner and with the same powers, obligations, and protections as the Receiver for the benefit of the existing creditors of Vert. In the result, all existing claims against Vert would be solely claims against the property in trust and would be administered by the trust.
The Receiver similarly argued that the Ontario Superior Court of Justice had the jurisdiction to grant the requested relief pursuant to section 243(1) of the BIA and the Ontario CJA. The Court granted the order sanctioning the transaction.
As described above, the jurisdictional basis for granting RVO orders under the CCAA is now well established. It appears that courts, at least in Ontario and on the basis of the circumstances before them, have found the jurisdiction and deemed it appropriate to grant an RVO in receiverships pursuant to both provincial legislation and the BIA.
Section 101 of the Ontario CJA grants the court the power to issue injunction relief and appoint a receiver or receiver and manager and provides that an order so doing may include such terms as are considered just. Similar provisions can be found in operative legislation in other common-law provinces, and by their plain wording afford courts broad jurisdiction in receiverships.
Likewise, subsection 243(1) of the BIA provides a broad grant of authority to courts, to be exercised within the confines of the scope and purpose of receiverships and with a view to achieving just and practical outcomes. As the Ontario Court of Appeal noted in Third Eye Capital Corporation v Resources Dianor Inc./Dianor Resources Inc., 2019 ONCA 508, section 243(1)(c) of the BIA grants courts the jurisdiction to authorize receivers to respond to the complex commercial realities with which they are faced, and to authorize what “justice dictates” and “practicality demands”.
Both the provincial and federal legislation work in harmony to empower a court to act in a practical manner to further the goals of receivership proceedings. The harmonious operation of applicable provincial and federal legislation serves to distinguish the potentially narrower interpretation given to section 243 of the BIA by the Supreme Court of Canada in Saskatchewan (Attorney General) v Lemare Lake Logging Ltd., 2015 SCC 53 (“Lemare Lake”).
That being said, owing to the specificity of Quebec’s civil law system and in light of the application of the SCC decision in Lemare Lake, RVOs in receivership contexts remains uncharted territory, at least in Quebec. Indeed, there is no statute precisely analogous to the Ontario CJA in Quebec.3 The Quebec Court of Appeal in Séquestre de Media5 Corporation,4 applying the dictates of Lemare Lake, ended a then-pending controversy in Quebec caselaw and confirmed that the substantive and procedural requirements of the Civil Code of Quebec5 must be satisfied for the court to appoint a receiver under 243(1) BIA.
Accordingly, among other criteria, the disposition of an insolvent person’s assets is subsumed to the same requirements that apply to hypothecary recourses, including namely the issuance of prior notices and expiration of 20- or 60-day delays (for movables or immovables, respectively). Moreover, while there are indeed “umbrella provisions” in the Code of Civil Procedure6 providing that the courts “have all the powers necessary to exercise their jurisdiction” or to “make such orders as are appropriate to deal with situations for which no solution is provided by law”, there is no broad discretionary authority akin to that which is found in the Ont CJA and applicable to receivership contexts per se.
In Canada as a whole, it remains to be seen how prevalent this practice can become, as a more generic vehicle. Indeed, the BIA receivership process does not typically feature the mechanisms ensuring broad participation and openness that are embedded in CCAA processes, where a broad range of stakeholders have a seat at the table. The particular facts of the case will also heavily impact the parties’ and the court officer’s ability to satisfy the BIA court that all affected parties have been duly notified and that no material prejudice will be suffered by other, sometimes absent, stakeholders.
It remains that the purpose of receiverships is to enhance and facilitate the preservation and realization of a debtor’s assets for the benefit of its creditors and stakeholders (see Third Eye, supra). If this purpose can be achieved through an RVO and the circumstances of the matter are conducive to such a mechanism, courts appear to be satisfied that they have jurisdiction to grant these orders in furtherance of these objectives.
Tevia Jeffries is a partner in the Restructuring, Insolvency and Bankruptcy group out of our Vancouver office. She is also licensed to practice in the state of New York. Tevia’s practice includes advising debtors, creditors, trustees and receivers on issues arising in corporate restructuring and insolvency proceedings, distressed asset purchases, debt recovery and security realization. Prior to joining Dentons, Tevia practised at Dewey & LeBoeuf LLP in New York in the area of corporate restructuring and bankruptcy law which included debtor and creditor representations, in and out-of-court restructurings, insurance insolvency and rehabilitation, corporate governance advice for distressed companies, debtor-in-possession financing, and distressed asset purchases.
John Regush is a senior associate in Dentons’ Restructuring, Insolvency and Bankruptcy group out of our Calgary office. His practice focusses on bankruptcy, receivership, and restructuring law, including strategic insolvency planning, insolvency litigation, and acting as counsel to debtor companies, creditors, monitors, and trustees in bankruptcy and restructuring proceedings. John also has experience in judgment enforcement and corporate litigation matters.
Jordan Schultz is a partner with Dentons’ Restructuring, Insolvency and Bankruptcy group, whose practice focuses on a range of commercial restructuring and insolvency matters. He is both an experienced litigator, having appeared at all levels of court in British Columbia, and a skilled commercial advisor, having represented clients on numerous financing, acquisition, and restructuring transactions.
Ari Sorek is a partner in the Restructuring, Insolvency and Bankruptcy group and in the Litigation and Dispute Resolution group out of our Montréal office. He specializes in corporate and commercial litigation, financial restructuring, bankruptcy and insolvency, as well as real estate related litigation. Ari has represented and advised various types of clients, operating in a wide range of industries (e.g.: tourism, retail, aviation, automotive, manufacturing, telecommunications, gaming, mining, construction), in numerous complex restructuring files, including several national and transnational matters. As such, Ari has represented creditors, debtors, trustees and court officers before the courts at both the trial and appellate levels.
1 See e.g., Re Stornoway Diamond Corporation (October 7, 2019), Montreal 500-11-057094-191 (Q.C.S.C. [Comm. Div.]); Comark Holdings Inc. (July 13, 2020), Toronto CV-20-00642013-00CL (Ont. S.C.J. [Comm. List]); JMB Crushing Systems Inc. (October 16, 2020), Calgary 2001-05482 (A.B.Q.B.).
2 See Arrangement relatif à Nemaska Lithium inc., 2020 QCCS 3218, leave to appeal denied 2020 QCCA 1488; Re Quest University Canada, 2020 BCSC 1883, leave to appeal denied 2020 BCCA 364.
3 The Quebec Code of Civil Procedure and Civil Code do contemplate the appointment of receivers towards specific ends, but the criteria for such an appointment and the powers entrusted to such receivers are such that they are rarely used, and are even less likely to be conducive to RVOs.
4 Séquestre de Media5 Corporation, 2020 QCCA 943 (CanLII).
5 CQLR c CCQ-1991.
6 CQLR, c. C-25.01.