Examining the Scope of Regulatory Carve-Outs in CCAA Proceedings

NORTH OF THE BORDER UPDATE

This article has been contributed to the blog by Andrea Lockhart and Tracy Sandler. Tracy Sandler is a partner and chair of the insolvency and restructuring group of Osler, Hoskin & Harcourt, LLP, and Andrea Lockhart is an associate in the group.
In connection with overhaul of the Companies’ Creditors Arrangement Act (“CCAA”) in 2009, section 11.1 of the CCAA was proclaimed into force which provides express statutory recognition that regulatory bodies are not bound by the CCAA stay of proceedings within certain limits. A “regulatory body” is defined in the Act as a person or body with powers, duties or functions relating to the enforcement or administration of a federal or provincial act, and includes certain prescribes regulatory bodies. Under this new provision, no stay of proceedings affects a regulatory body’s investigation of a debtor company or an action, suit or proceeding in respect of a debtor company, other than the enforcement of a payment ordered by the regulatory body or the court. This exception to the stay has given rise to litigation in recent years as to what point a regulatory body’s investigation, action, suit or proceeding gives rise a monetary claim against the debtor that is caught by the CCAA stay. The Ontario Superior Court of Justice (Commercial List) (the “Ontario Court”) recently considered this issue in the CCAA proceedings of Northstar Aerospace, Inc., Northstar Aerospace (Canada) Inc., 2007775 Ontario Inc. and 3024308 Nova Scotia Company (collectively, the “Canadian Entities”).
The Canadian Entities brought a motion before the Ontario Court for, among other things, an order approving an asset sale agreement between certain of the Canadian Entities, certain of their U.S. affiliates in such affiliates’ Chapter 11 restructuring proceedings, a Canadian purchaser and a U.S. purchaser for the sale of certain of Northstar’s assets as a going concern. The proposed purchased assets did not include a non-operating Canadian facility in respect of which certain historical environmental contamination issues arose prior to the CCAA proceedings. Such environmental contamination had migrated from beneath the facility to beneath nearby homes and raised various public health and safety concerns. As a result, three months prior to the CCAA proceedings the Ontario Ministry of the Environment (“MOE”) issued an order under the Environmental Protection Act (Ontario) (the “EPA”) requiring the Canadian Entities to undertake certain activities to monitor, mitigate and remediate the contamination where necessary (the “March Order”). The MOE issued a further order one month prior to the CCAA proceedings requiring the Canadian Entities to provide approximately $10 million in financial assurance by way of certified cheque or irrevocable letter of credit to fund the measures contemplated by the March Order.
Since the discovery of the environmental contamination, the Canadian Entities had conducted remediation activities on a voluntary basis. These activities continued after the granting of the initial CCAA order with the consent of the first secured lender, who had provided both the pre-CCAA credit facility and a DIP loan. However, the first secured lender advised that it would not fund such remediation following the asset sale. In this case, the total proceeds of sale would not be sufficient to repay the first secured lender, resulting in a projected shortfall of approximately $10 million.
In connection with the sale approval motion before the Ontario Court, the Canadian Entities sought an authorization and direction for the CCAA monitor to distribute the proceeds of sale to the first secured lender.  The MOE sought a declaration that the March Order was a regulatory order pursuant to section 11.1 of the CCAA and therefore not subject to the stay of proceedings, or in the alternative, to lift the stay of proceedings in order to permit continued enforcement of the March Order against the Canadian Entities. The MOE also sought an order that the asset sale transaction not be approved, or if approved, that no proceeds be distributed pending further submissions before the Ontario Court as to the distribution of proceeds.
The day immediately prior to the hearing of the motion, the MOE issued a notice of constitutional question to the Attorney General of Canada as to whether the interpretation of section 11.1 of the CCAA upset the balance of federal power over bankruptcy and insolvency granted by the Constitution Act, 1867 and the provincial regulatory authority over the environment granted by such Act. As the Attorney General was not prepared to respond, the MOE requested an adjournment of the constitutional issue. The Ontario Court refused to grant the requested adjournment on several grounds. First, the MOE had been aware of the environmental issues since prior to the CCAA proceedings. In addition, a similar issue had been litigated in the Nortel CCAA proceedings wherein the Ontario Court held that certain MOE orders, if issued, were, in substance, financial obligations for Nortel that were subject to the CCAA stay of proceedings. Finally, the proposed transaction was scheduled to close shortly after the hearing and it was not feasible to adjourn the motion and also comply with commercial requirements.
As to the scope of the CCAA stay of proceedings, the Ontario Court held that exceptions to the stay should be narrowly interpreted. Referring to its judgment in the Nortel CCAA proceedings, the Ontario Court noted that where a debtor is insolvent and is not carrying on operations at the property in question, one must consider the substance of the regulatory body’s actions. This was not a case where the debtor operated at the facility and could comply with an EPA order on an ongoing basis. Rather, the result of the March Order was to require the Canadian Entities to incur a financial obligation to comply with environmental issues. Such result was tantamount to enforcing a payment obligation, which was prohibited by the stay.
The Ontario Court did note that section 11.8 of the CCAA provided for a claim in favour of the MOE for costs of remediation, which claim was secured by a charge on the real property and enforceable in accordance with the law of the jurisdiction in which the real property was located, ranking above any other claim, right or charge against the property. While the MOE was entitled to file such claim for remediation costs against the Canadian Entities, it was not entitled to attempt to use the March Order to create a priority it was not otherwise entitled to under the legislation.
While noting that the environmental concerns were serious, the Ontario Court ultimately approved the asset sale transaction and the proposed distribution to the first secured creditor. In this case, the Ontario Court noted no bidder was willing to purchase the contaminated facility. In addition, if the transaction were not approved, the first secured creditor would proceed to enforce its rights and had a superior priority position to the MOE.  Accordingly, regardless of whether the transaction was approved or not, the Canadian Entities would not have the financial ability to comply with the March Order.

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