Restructuring

NORTH OF THE BORDER UPDATE

This article has been contributed to the blog by Rupert Chartrand, Marc Wasserman and Martino Calvaruso. Rupert Chartrand and Marc Wasserman are partners in the Insolvency and Restructuring Group of Osler Hoskin & Harcourt LLP, and Martino Calvaruso is an associate in the Group.
On April 7, 2011, the Ontario Court of Appeal released its long-awaited decision in Re Indalex Limited. In a unanimous decision, the Court of Appeal ordered FTI Consulting Canada ULC (the “Monitor”) to pay from the reserve fund (the “Reserve Fund”) held by the Monitor from the sale of Indalex Limited, Indalex Holdings (B.C.) Ltd., 6326765 Canada Inc. and Novar Inc. (collectively, “Indalex”) and Indalex’s parent company and its U.S. based affiliates (collectively, “Indalex U.S.”) amounts sufficient to satisfy the deficiencies in its two underfunded pension plans: (i) the Retirement Plan for Salaried Employees of Indalex Limited and Associated Companies (the “Salaried Plan”) and (ii) the Retirement Plan for Executive Employees of Indalex Limited and Associated Companies (the “Executive Plan”, and together with the Salaried Plan, the “Plans”). Indalex was the sponsor employer and administrator of the Plans.
The payment was ordered to be made in priority to the claims of Indalex U.S., the holder of a debtor-in-possession (“DIP”) super-priority charge (the “DIP Charge”) as it fully satisfied the claims of the original DIP lenders under a guarantee and thereafter became subrogated to the rights of the DIP lenders, and Sun Indalex Finance LLC (“Sun Indalex”), Indalex U.S.’s principal secured creditor. Indalex U.S. was under Chapter 11 protection in the United States. In effect, the U.S. estate, and its U.S. creditors to whom it owed fiduciary duties under the U.S. Bankruptcy Code as a debtor-in-possession, funded the Canadian pension deficiencies.
In Re Indalex, the Court of Appeal granted priority to the statutory deemed trust (the “Deemed Trust”) contemplated by Section 57(4) of the Pension Benefits Act (the “PBA”) relating to the Salaried Plan’s deficiency over the claims of Indalex U.S. and Sun Indalex. The Court of Appeal granted such relief despite the fact that the DIP Charge specifically noted that it was to be in priority to trusts, statutory or otherwise. According to the Court of Appeal, the CCAA court made no finding of paramountcy of federal law over provincial law at the time the DIP Charge was granted. Nothing before the CCAA court suggested that the federal and provincial laws were incompatible: that it would be impossible to comply with both statutes or that the provincial law acts to frustrate its federal counterpart.
The Court of Appeal also held that Indalex wore both its corporate and administrator “hats” throughout its proceedings under the CCAA and was required to discharge its duties in respect of both roles. According to the Court of Appeal, Indalex breached its fiduciary obligations as administrator of the Plans by, amongst other things, (i) taking actions to undermine the possibility of additional funding for the Plans, (ii) obtaining CCAA protection without notice to the Plans’ beneficiaries, (iii) seeking DIP financing and providing DIP lenders with a DIP Charge in priority to trusts, statutory or otherwise, without providing notice to the Plans’ beneficiaries, (iv) selling assets without making provision for additional funding for the Plans, (v) moving for an order authorizing the distribution of the sale proceeds to the DIP lenders fully knowing that no funds would be put towards the Plans’ deficiencies, and (vi) bringing forward a bankruptcy motion seeking to defeat the Deemed Trust claim and ensuring the payment of the Reserve Fund to Indalex U.S. and Sun Indalex. The Court of Appeal noted that it was clear that Indalex was in a conflict of interest position as a result of its corporate duties conflicting with its duties as administrator of the Plans. As a result, the Court of Appeal granted equitable relief and imposed a constructive trust on the Executive Plan’s deficiency in priority to the claims of Indalex U.S. and Sun Indalex. The Court of Appeal set out the conditions that must “generally be satisfied” for the application of a constructive trust and concluded that, given Indalex’s breaches of its fiduciary obligations, such a trust would be appropriate in the circumstances.
Irrespective of the Court of Appeal’s position in Re Indalex, by granting the Deemed Trust priority over the DIP Charge, the Court of Appeal has likely made it more difficult for future debtors to secure DIP financing. Prospective DIP lenders will be concerned by the holding of Re Indalex, due to the fact that Indalex’s DIP lenders advanced funds in reliance of the DIP Charge only for the DIP Charge to later be subordinated to the interests of the Plans’ beneficiaries. The decision in Re Indalex creates further uncertainty because it provides that the determination of priority is to be done on a case-to-case basis depending on the facts of each respective case determined after the DIP funds are advanced and for the possibility that a CCAA court may elect to impose a constructive trust over certain funds if the equities so permit.
Moving forward, motions for the approval of DIP financing will need to specifically address the issue of federal paramountcy with respect to the Deemed Trust, include greater evidentiary support for the imposition of a debtor-in-possession charge in priority to the Deemed Trust and any constructive trust, and be accompanied by service or notice to the applicable pension plan beneficiaries. This is impractical because: (i) in the early stages of a CCAA proceeding, an insolvent debtor requires strong assurances that it will have access to liquidity to achieve a successful restructuring, and (ii) an insolvent debtor’s ability to operate as a going concern during the CCAA proceeding can be frustrated if it is required to give notice to a widespread group of stakeholders, as knowledge of such debtor’s CCAA proceeding can become known prior to its formal commencement, which may cause parties to seek to terminate executory contracts with the debtor. The decision in Re Indalex also puts at risk the position of other secured creditors, including working capital lenders, as well as other priority court charges, such as the administration charge to protect the court-appointed monitor and the directors’ and officers’ charge to protect directors and officers during the CCAA restructuring.
In determining that Indalex breached its fiduciary obligations as administrator of the Plans during the CCAA proceeding, the Court of Appeal has opened the door for increased obligations and liabilities on debtors. Such debtors will now have to address and discharge such fiduciary obligations or risk pension plan beneficiaries seeking equitable relief and being granted priority to the other creditors of the estate. To impose constructive trusts during an insolvency proceeding without any statutory authority to do so greatly upsets the balance of creditor interests, even more so when creditors in another foreign proceeding are forced to “foot the bill” for a particular group of Canadian creditors. As a result of these onerous obligations, debtors may seek the appointment of an independent pension plan administrator, which will be subject to the approval of the regulator. However, such approval may be difficult to achieve in the circumstances, thereby subjecting such debtors to unnecessary risks and uncertainty in their CCAA proceedings.
The decision of the Court of Appeal is Re Indalex is a significant shift in the longstanding practice of dealing with pension plan obligations in CCAA restructurings and presents a number of new challenges and issues for prospective CCAA debtors. Re Indalex exposes every creditor to the risk that its interests may be subsequently primed if a CCAA court determines it to be equitable to do so and places debtors in the near impossible position of having to discharge duties which will inevitable conflict.

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