Restructuring

NORTH OF THE BORDER UPDATE

This article has been contributed by Sandra Abitan and Julien Morissette, respectively partner and associate in the Insolvency and Restructuring Group of Osler, Hoskin & Harcourt LLP.

Debtor-in-possession financing is a well established feature of Canadian commercial insolvency proceedings. Generally, it is advanced directly to the debtor, in return for a court-ordered super-priority charge on the assets. However, an Ontario court recently authorized an interim receiver to borrow $1.5M to satisfy an insolvent company’s payroll and ongoing contractual obligations, secured with a super-priority charge on the company’s assets. It remains to be seen whether this will be a one-time event or a new, indirect route to achieve a result akin to DIP financing.

Comstock Canada Ltd. (Comstock) is a large construction contractor doing business across Canada. The company ran into financial difficulty, defaulted on its secured loan and was locked out by one of its major clients. The day after the lock out, the company filed a notice of intention to make a proposal to its creditors (NOI) under the Bankruptcy and Insolvency Act.

It quickly became apparent that to continue operations and pay employees and subcontractors, Comstock needed additional liquidity, barring which many projects would be seriously disrupted. Comstock brought an urgent motion before the Ontario Superior Court of Justice, seeking appointment of PricewaterhouseCoopers Inc. (PwC) as interim receiver, for the limited and specific purpose of authorizing PwC to borrow $1.5M to meet the company’s immediate obligations. Comstock’s pre-filing secured lender agreed to provide the financing, provided it was secured with a first-priority charge over the company’s assets.

Comstock advised the Court that it was contemplating making a motion to continue the proceedings under the Companies’ Creditors Arrangement Act. Resorting to the CCAA had been seriously considered earlier in the process, however Comstock urgently needed to obtain a stay to prevent a potential cascade of contract terminations by clients and suppliers. While the NOI – which is filed without court authorization – was effective in that respect, it had the collateral effect of preventing Comstock from obtaining any additional operating funding from its secured lender and preventing it from clearing about $1.9 million of oustanding payments.

Justice Morawetz endorsed the motion, with reasons given nine days later. He found that the sought order was protective of the estate and in the interest of creditors, while the alternative was a “chaotic situation”. Importantly, the Court found that the super-priority charge would not have a material effect on the positions of other secured creditors, including holders of construction liens or of a trust funds claim.

Both the CCAA and the BIA (as regards proposals) contain explicit provisions governing DIP financing. For example, the BIA provides that the following factors should be considered by a court before granting a super-priority charge:

(a) the period during which the debtor is expected to be subject to proceedings (…);

(b) how the debtor’s business and financial affairs are to be managed during the proceedings;

(c) whether the debtor’s management has the confidence of its major creditors;

(d) whether the loan would enhance the prospects of a viable proposal being made in respect of the debtor;

(e) the nature and value of the debtor’s property;

(f) whether any creditor would be materially prejudiced as a result of the security or charge; and

(g) the trustee’s report…

The BIA provisions governing interim receiverships permit the granting of a super-priority charge to secure the fees and disbursements of the interim receiver, but carves out disbursements which are “payments made in operating a business of the debtor”. While it does not contain any prohibition, these BIA provisions are silent as to whether a charge of the sort sought by Comstock is permissible and, if so, under what conditions.

Justice Morawetz did not explicitly apply the BIA proposal (or CCAA) criteria by analogy. That being said, in his reasons, he applies a similar cost-benefit analysis. The Court held that the objectives of the BIA and CCAA would be frustrated in the absence of a super-priority charge to secure a loan to PwC. Ultimately, Justice Morawetz concluded that “the charge could be granted under the inherent jurisdiction of the court” and gave the green light to the $1.5M loan.

It remains to be seen whether this scenario is susceptible to repetition. The BIA proceedings were in fact continued under the CCAA a few days following the endorsement. Comstock was in a relatively unusual situation. It needed to avoid a freefall and bridge its way to the flexible protection provided by the CCAA in order to effect an operational restructuring. The judgment rendered in this case confirms that it is possible for an interim receiver to be the borrower, for the specific purpose of funding the debtor’s operations. However, the Court only provided a modicum of guidance to the insolvency bar as to elements which may be considered in the future. Undoubtedly, the level of urgency and the anticipated effect on other secured creditors will be key, but outlining other considerations, if any, was left for another day.

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