No way out – Ontario insolvency court approves class action settlement that prohibits any affected person from opting out

NORTH OF THE BORDER UPDATE

This article has been contributed to the blog by Mary Paterson and Patrick Riesterer. Mary Paterson is a senior associate in the litigation group of Osler, Hoskin & Harcourt LLP and Patrick Riesterer is an associate in the insolvency and restructuring group of Osler, Hoskin & Harcourt LLP.

In the ongoing Sino-Forest Corporation insolvency saga, the Ontario Superior Court of Justice approved: (i) a settlement of the class action against Ernst & Young LLP and (ii) a plan of compromise and arrangement in respect of Sino-Forest filed in the proceedings commenced by Sino-Forest under the Companies’ Creditors Arrangement Act. Among other things, the Plan provided Ernst &Young with a third party release of all claims against it in the Sino-Forest class action.

As explained in our previous post on the Sino-Forest proceedings, certain shareholders and noteholders of Sino-Forest commenced a class action in Ontario (and other jurisdictions) against Sino-Forest, Ernst &Young and a number of other entities. The plaintiffs alleged that Sino-Forest misrepresented its assets and financial situation, artificially inflating the price of Sino-Forest’s shares and notes. Ernst &Young’s potential liability related to its activities as Sino-Forest’s former auditor. Sino-Forest was subsequently granted protection under CCAA.

The Ad-Hoc Committee of Purchasers of the Applicant’s Securities (“Ad Hoc Committee”), representing the plaintiffs in the Class Action, brought a motion in the CCAA proceedings for approval of the settlement and approval of the Plan, including the third party release of Ernst & Young. The settlement created a fund of $117 million for distribution to the security holders of Sino-Forest and included a provision that prohibited any Security Holder from opting out of the settlement. The settlement was conditional on, among other things, the Plan containing the release of Ernst & Young.

A small number of the security holders objected to the approval of the settlement and the release. The objecting security holders argued that the Ontario Class Proceedings Act, 1992 requires class action settlements to permit class members to opt out of the settlement. In addition, the objecting security holders argued that the settlement and the release were not necessary for the success of or even related to the Sino-Forest’s restructuring plan.

The Court Approves the Settlement

The Court recognized that a class action settlement must ordinarily include an opt out provision: the right to opt out of a class action settlement is a fundamental element of procedural fairness in the Ontario class actions regime. 

However, the Court observed that it is not possible to ignore the CCAA proceedings when assessing whether or not the objecting security holders should have a right to opt out of the settlement. The Court noted that claims, including contingent claims such as class action claims, are regularly compromised and settled in the CCAA. Such compromises occur where (i) a majority of creditors representing two thirds in value of the claims against the estate vote in favour of a plan, and (ii) a court approves the plan as fair and reasonable. A creditor who has a claim that is compromised by a plan and who voted against the plan does not have a right to opt-out of the compromise. Instead, the compromise is imposed on such creditor despite the creditor’s objections. In the case of Sino-Forest, the Plan contemplated the settlement and had been approved by the requisite majority of creditors; it would therefore be contrary to the CCAA to permit the objecting security holders to opt out of the settlement.

The Court also Approves the Third Party Release

The Court also found that the third party release was reasonable in the circumstances. The Court explained that the CCAA contains a mechanism for the compromise, arrangement and release of claims against third parties where: (i) the release is rationally related to the purpose of the plan; (ii) the release is necessary for the plan; (iii) there is a tangible contribution to the plan by the released parties; (iv) the release is beneficial for both the debtor and the creditors generally; (v) the plan has been approved by creditors who have knowledge of the nature and effect of the release; and (vi) the release is fair and reasonable and not overly broad or offensive to public policy.

The Court found that the release exhibited all the elements necessary for court approval:

  1. The release was rationally related to the purpose of the Plan because the Plan provided for a distribution to Sino-Forest’s creditors and the $117 million to be contributed by Ernst & Young pursuant to the settlement was the only identifiable value available to Sino-Forest’s creditors. 
  2. The release was necessary for the Plan because the claims against Ernst & Young were inseparable from the claims against Sino-Forest (see our post on the equity claims). The claims of the Ad-Hoc Committee and the objecting security holders against Ernst & Young were also inseparable from their claims against Sino-Forest.  Furthermore, Ernst & Young had a claim for contribution and indemnity from Sino-Forest.
  3. The release involved a tangible contribution to the Plan because the settlement and the release were inextricably intertwined and resulted in value to be distributed to creditors, the withdrawal of many objections to the Plan and the avoidance of protracted and uncertain litigation.
  4. The release provided a benefit to the debtor and the creditors generally for all of the reasons set out above.
  5. The release was part of a Plan that was approved by the requisite majority of creditors, all of whom had knowledge of the nature and effect of the release.
  6. The release was fair and reasonable and not overly broad or offensive to public policy.

The Court therefore approved the settlement and the Plan containing the third party release of Ernst & Young.

 Implications

This decision shows the power of the CCAA in facilitating the settlement of all claims in respect of an insolvent enterprise, even where that settlement is in respect of third parties and requires the Court and parties to deviate from the legal regime that would ordinarily apply to such a settlement. Second, the decision sets out the factors governing whether or not the parties should take comfort from the Court’s willingness to grant releases to third parties who are making a tangible contribution to the restructuring plan put forward by an insolvent company.

The objecting security holders have since filed an appeal of the Court’s decision. We will keep you updated of any interesting developments on appeal.

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