Restructuring

NORTH OF THE BORDER UPDATE

This article has been contributed to the blog by Steven Golick and Sachin Kanabar.  Steven Golick is a partner in the Insolvency and Restructuring Group of Osler Hoskin & Harcourt LLP and Sachin Kanabar is an associate in the group.

In Ford Credit Canada Ltd. v. Welcome Ford Sales Ltd., the Alberta Court of Appeal (the “Court of Appeal”) addressed whether a trustee in bankruptcy (the “Trustee”) of an auto dealership (“Welcome Ford”) can sell and assign its dealership agreement (the “Agreement”) with its franchisor, Ford Motor Company of Canada, Limited (“Ford”), to a purchaser (the “Purchaser”) notwithstanding the objection of the franchisor.  At the heart of the case was the interpretation a relatively recent statutory amendment  that authorizes a court to order an assignment of an agreement to which the bankrupt is a party notwithstanding the objection of the other party to the contract.

Welcome Ford operated a franchise dealership with Ford pursuant to the terms of the Agreement.  The dealership ceased operations after an audit by Ford Credit Canada Ltd. (“Ford Credit”) revealed that senior employees of Welcome Ford had misappropriated funds from the dealership.  Myers Norris Penny (“MNP”) was appointed as the receiver of Welcome Ford on application by Ford Credit.  Welcome Ford had two secured creditors:  the Bank of Montreal (“BMO”) and Ford Credit.  Ford Credit had priority to Welcome Ford’s inventory of vehicles, while BMO had priority over all of the other assets.  Ford Credit seized all of Welcome Ford’s vehicles.

The court order appointing MNP as receiver provided for a stay of proceedings, which prohibited agreements from being terminated without the consent of the court appointing the receiver.  Ford made it clear early on that it would not consent to the assignment or sale of the Agreement and brought an application to lift the stay of proceedings so that it could terminate the Agreement.  The court adjourned Ford’s application and granted an order to MNP to market what remained of Welcome Ford’s dealership.

BMO subsequently obtained an order placing Welcome Ford into bankruptcy and MNP was appointed as the Trustee.  The Purchaser was the successful bidder for the dealership in the Trustee’s marketing process.  The Purchaser was a reputable owner of another Ford dealership.

The Purchaser’s offer would have produced sufficient funds to repay the secured obligation to BMO and provide for a distribution to unsecured creditors.  By contrast, a liquidation of Welcome Ford would leave BMO with a shortfall on its debt and leave nothing for other creditors.  Despite this, Ford still refused to consent to the assignment of the Agreement, which was integral to the sale.

As a result, the Trustee applied to the court of Alberta Queen’s Bench (the “Lower Court”) to compel the assignment of the Agreement to the Purchaser pursuant to section 84.1 (“Section 84.1”) of the Bankruptcy and Insolvency Act. This provision allows a court, upon being satisfied that certain prerequisites are met, to grant an order assigning the rights and obligations of the bankrupt under any agreement to a purchaser, even without the consent of the counterparty to the agreement.  The Lower Court granted the Trustee’s application and Ford appealed the decision.

This is the first reported appellate case to consider Section 84.1.  Prior to this provision’s enactment on September 18, 2009, bankrupt estates were vulnerable to losing the benefit of a valuable contract to the detriment of all creditors if the counterparty did not consent to its assignment.  Section 84.1 remedies this vulnerability by permitting the assignment over the objection of the counterparty.  The court is required to consider certain factors and cannot order the assignment if all monetary defaults have not been cured, thus preserving some of the rights and remedies of the counterparty.  The section is intended to provide flexibility for the court to review each contract in light of the circumstances.

In its appeal, Ford posited two arguments as to why the sale should not be permitted. The first was that the Agreement had been terminated as a result of a fundamental breach that occurred before the granting of the receivership order such that there was nothing left to assign to the Purchaser.  Alternatively, it argued that the Agreement fell within one of the exceptions to Section 84.1, namely, that the Agreement was not of a nature that was assignable.

Ford argued that the abandonment of the business and Smith’s failure to supervise his employees (in connection with the misappropriation) amounted to a fundamental breach of the Agreement prior to the appointment of the receiver and therefore the Agreement was terminated and could not be assigned.  This argument was dismissed by the Court of Appeal.  The Court of Appeal first queried whether the doctrine of fundamental breach continues to exist in Canada, given certain rulings by the Supreme Court of Canada in the context of exclusion clauses.  In any case, the Court of Appeal concluded that even if fundamental breach did exist in Canadian law, Ford could not succeed on this argument.  In order to prove fundamental breach, it must be shown that the non-breaching party was deprived of the entire benefit of the contract.  The Court of Appeal found that this was not the case with respect to Ford.  Rather, the Court of Appeal held that Ford’s own actions prevented the business from being continued and the misappropriation of funds did not deprive it of the whole benefit of the Agreement.

The next issue was whether the nature of the Agreement was such that it was not assignable under Section 84.1.  Section 84.1 has certain exceptions, one of which provides that the court may not order the assignment if the contract is not assignable by its nature.  Ford had argued that the Agreement was not assignable by its nature and the Lower Court dismissed this argument.  Ford appealed this issue on three grounds.

First, Ford argued that the Lower Court incorrectly made reference to certain factors in determining the nature of the Agreement.  Section 84.1 provides that, in deciding whether to order the assignment of a contract, the court must consider (i) whether the assignee is able to perform the obligations under the contract and (ii) whether it is appropriate to assign the rights and obligations to that assignee.  The Lower Court considered these factors in determining that the Agreement was assignable by its nature.  On appeal to the Court of Appeal, Ford argued that such factors are only to be considered in determining whether the circumstances warrant that the order should be made but are irrelevant to determining the nature of the contract itself.  The Court of Appeal disagreed.

The Court of Appeal reasoned that Parliament’s intent in enacting Section 84.1 was to protect and enhance the assets of the bankrupt’s estate for the benefit of all creditors by permitting the sale or assignment of contracts to third parties notwithstanding the objections of the counterparty to the agreement.  The appellate court also took into consideration that Section 84.1 only permitted the assignment if all monetary defaults under the contract have been cured.  As a result, the Court of Appeal concluded that the suitability of the assignee and the appropriateness of the assignment are relevant factors that may be considered in determining the nature of the Agreement.

Second, Ford argued that the Agreement was not assignable by its nature because there was not sufficiently clear evidence that the bankrupt estate would benefit from its assignment.  Ford relied on case law stating that the court should not exercise its discretion to override a counterparty’s contractual right to withhold consent without such clear evidence.  The Court of Appeal distinguished the case law relied on by Ford on the basis that, in those cases, the court was asked to re-write or imply missing terms in the contract.  In this case, all of Ford’s rights and obligations under the Agreement were to remain the same; the only change was the identity of the dealer from Welcome Ford to the Purchaser.  Further, given that the sale of the Agreement would generate sufficient funds to allow BMO to be paid in full and likely result in distributions to unsecured creditors, whereas the alternative liquidation scenario would create a shortfall for BMO, the Lower Court’s decision that the estate would benefit was reasonable.

Third, Ford further argued that the rights and obligations under the Agreement were not assignable by their nature because they were personal.  In particular, Ford referred to certain provisions in the Agreement that provided Ford with certain discretion, such as the right to approve any change of control or determine the locations of its dealerships, in order to characterize the Agreement as personal.  The Court of Appeal rejected this argument, as well.  A contract that is “personal” is one that cannot be usefully performed by another.  An example would be a contract for employment.

The Agreement in this case was a standard commercial franchise contract that could be performed by anyone with capital and experience in auto retailing.  There was nothing particular under the Agreement that Smith himself provided.  In addition, the provisions in the Agreement relied on by Ford did not make the Agreement a personal one.  Parties to a contract cannot avoid the application of Section 84.1 by including a clause describing it as creating “personal” obligations, where the substance of the contract is a commercial one that can be performed by others.

The Court of Appeal then considered whether the Purchaser had the capacity to perform the Agreement and whether it was appropriate in the circumstances of the case to assign the Agreement to the Purchaser.  The Lower Court found that the Purchaser was a well-reputed and established owner of another Ford dealership and Ford did not provide any evidence to the contrary.  Accordingly, the Court of Appeal had no problem finding that the Purchaser had the capacity to perform the obligations under the Agreement.

Regarding the appropriateness of the assignment, the Court of Appeal accepted the Lower Court’s consideration of the following factors in determining that the assignment was warranted:  the capacity of the Purchaser to do the job, that the assignment would substantially cure the breaches under the Agreement and that all of Ford’s rights and remedies would remain unchanged and continue against the Purchaser.  The Court of Appeal also accepted the Lower Court’s consideration of its finding that Ford unreasonably withheld its consent as a factor in determining that the assignment was appropriate.

This is the first case that deals with the interpretation of Section 84.1.  The Court of Appeal’s decision demonstrates the significant power that the provision grants a court to order the assignment of an agreement in appropriate circumstances despite the objection of the counterparty to the contract.  It significantly enhances an estates ability to realize on its contractual assets.  It will be interesting to see how future cases continue to refine the interpretation of Section 84.1.

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