Restructuring

NORTH OF THE BORDER UPDATE

This article has been contributed to the blog by Edward Sellers and Patrick Riesterer. Edward Sellers is a partner in the insolvency and restructuring group of Osler, Hoskin & Harcourt LLP, and Patrick Riesterer is an associate in the group.
The government of Canada recently introduced Bill C-45, the Jobs and Growth Act, which includes amendments to several provisions of the Canada Deposit Insurance Corporation Act (the “CDIC Act”) and the Payment Clearing and Settlement Act (the “PCSA”), two statutes that deal in part with the insolvency of financial institutions in Canada. 
The amendments appear to have been introduced, in part, to meet commitments made by Canada and other G-20 countries at the 2009 Pittsburgh Summit of G-20 leaders, where the G-20 agreed that “All standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest.” The amendments appear to support this objective by clarifying the scope of the certain exemptions from the stay of proceedings for the termination of certain derivatives contracts (“EFCs”), netting of obligations under such contracts and dealing with financial collateral related to such contracts (the “EFC Safe Harbours”).
These statutes and the amendments to them are highly complex. Readers are cautioned that as this is a summary overview of select issues only and should not be relied on as a replacement for a detailed review of the law.
Current Law – The CDIC Act
The CDIC Act applies to Canadian banks and other federal deposit taking institutions (“FIs”).  To facilitate the restructuring of an FI which is on the edge of insolvency, the Governor in Council (Canada) may issue, on the recommendation of the federal Minister of Finance, an order (a “CDIC Order”) under the CDIC Act vesting the shares and subordinated debt of the FI in the Canada Deposit Insurance Corporation (“CDIC”) or appointing CDIC as a receiver of the FI.  If CDIC is appointed receiver of the FI, the CDIC Order may also direct the Minister of Finance to incorporate a so-called “bridge institution”.
A bridge institution is created as part of the restructuring process as a subsidiary of CDIC to effect a transfer of the business operations which can be effectively restructured to a new solvent financial institution which can carry on the business on a properly capitalized and solvent basis. If a bridge institution is incorporated, CDIC must provide the financial assistance that the bridge institution needs in order to discharge its obligations as they become due.
When a CDIC Order is made, no creditor has any right of set-off against the FI and no person may terminate or amend any agreement with the FI or claim an accelerated payment under an agreement with the FI by reason only of the insolvency of the FI, a default by the FI or the seizure of assets by CDIC, unless a Canadian court grants leave to do such a thing.  The CDIC Act also contains limited EFC Safe Harbours, which allow the solvent counterparty to exercise rights of termination, netting and realization on financial collateral provided for in an EFC, notwithstanding the broad stay applicable to creditors.
If the CDIC Order directs the incorporation of a bridge institution, the EFC Safe Harbours do not apply and the solvent counterparty is prohibited from exercising its rights of termination, netting and realization on financial collateral by reason only of (i) the FI’s insolvency, (ii) the appointment of a receiver of the FI, or (iii) the assignment to or assumption by the bridge institution of the EFC, unless otherwise ordered by the court.  In order for the stay of the EFC Safe Harbours to be effective, CDIC must provide an unconditional guarantee of the payment by the FI of an amount due or that may become due in accordance with the provisions of the EFC or CDIC must ensure that all obligations arising from the EFC will be assumed by the bridge institution.
The solvent counterparty is not prohibited from terminating an EFC and netting the obligations under the EFC in accordance with its terms where there has been: (a) a non-monetary default by the FI in the performance of its obligations under the EFC; or (b) a monetary default by the FI which is not remedied by the bridge institution within 60 days, or such shorter period as ordered by the court, following the assignment of the EFC.
If the CDIC Order directs the incorporation of a bridge institution, CDIC may assign to the bridge institution any and all assets and agreements entered into by the insolvent FI, including EFCs, notwithstanding any contractual prohibition of assignments.   If CDIC assigns an EFC to a bridge institution, CDIC must assign all EFCs between the FI and the counterparty and between the FI and any entity that is related to the counterparty. In addition, CDIC must assign the FI’s interest in any property that secures the FI’s obligations under an EFC that is transferred to a bridge institution. 
CDIC is not able to assign an EFC if it has been previously terminated.
Current Law – The PCSA
The PCSA is intended to promote the stability of the financial system in Canada by giving the Bank of Canada the ability to designate certain clearing and settlement systems and certain clearing houses that operate clearing and settlement systems as systemically important. Where the Bank of Canada has designated a clearing and settlement system or a clearing house that operates a clearing and settlement system, the settlement rules of the clearing and settlement system may benefit from certain exemptions such that the rules of the clearing and settlement system are valid and binding notwithstanding certain provisions of Canadian law and court orders (the “PCSA Exemptions”). One such PCSA Exemption is an exemption from any law relating to bankruptcy or insolvency and any order of a court, including a foreign court, made in respect of a reorganization, arrangement or receivership that has the effect of interfering with the ability of a clearing house to act in accordance with the settlement rules of its clearing and settlement system.  Another PCSA Exemption is a protection analogous to the EFC Safe Harbours for “Netting Agreements”, including EFCs, between financial institutions.
Amendments in Bill C-45
Amendments to the CDIC Act
Bill C-45 introduces a number of amendments to the CDIC Act, including a clarification regarding the duration of the stay of the EFC Safe Harbours that occurs upon the issuance of a CDIC Order directing the incorporation of a bridge institution.  Previously, the duration of the stay was unclear. Pursuant to new section 39.15(7.01) of the CDIC Act, the EFC Safe Harbour is stayed upon the issuance of a CDIC Order directing the incorporation of a bridge institution for a period that begins when the CDIC Order comes into force and ends on the following business day at 5:00 pm eastern time (a “1 Day Stay”).  Pursuant to new section 39.15(7.02) of the CDIC Act, a 1 Day Stay does not apply to clearing and settlement systems and clearing houses designated under the PCSA. 
In addition to the 1 Day Stay, new sections 39.15(7.1) and (7.11) of the CDIC Act appear to operate such that the 1 Day Stay becomes permanent upon CDIC guaranteeing the performance of the obligations arising under an EFC or assigning the EFC to a bridge institution.
Amendments to the PCSA
Bill C-45 introduces a number of amendments to the PCSA, including an amendment that broadens certain definitions to make clearing houses that clear derivatives contracts eligible for the PCSA Exemptions and to make collateral posted to such clearing houses qualify as financial collateral.
In addition, the definition of “Netting Agreement” is amended such that an agreement between a customer and a member of a clearing house that provides clearing and settlement services to that customer qualifies as a Netting Agreement and is therefore granted protections analogous to the EFC Safe Harbours.
The amendments also appear to be intended to clarify the interaction between the limitations on the EFC Safe Harbours provided in the CDIC Act and the PCSA Exemptions.  The amendments create exceptions to the PCSA Exemptions that apply where the effect of the CDIC Order and subsequent actions by CDIC stay the EFC Safe Harbours provided for in the CDIC Act.  The apparent purpose of these amendments is to provide designated clearing and settlement systems and designated clearing houses (i) with an exemption from the 1 Day Stay so that they can terminate EFCs with an insolvent financial institution before such EFCs are transferred to a bridge institution; and (ii) a limit to that exemption such that they are stayed from terminating any EFCs that have been guaranteed by CDIC or transferred to a bridge institution.
Comment
We welcome the apparent intention behind the amendments proposed in Bill C-45. Clarity is desirable as to the duration of the stay of the EFC Safe Harbours that occurs upon the issuance of a CDIC Order directing the incorporation of a bridge institution.  Clarity is also desirable as to the interaction between the CDIC Act and the PCSA.
The amendments to CDIC Act and the PCSA appear to operate such a 1 Day Stay applies upon the making of a CDIC Order that directs the incorporation of a bridge institution, but the 1 Day Stay is subject to the PCSA Exemptions. The 1 Day Stay appears to become permanent upon CDIC guaranteeing the performance of the obligations arising under an EFC or assigning the EFC to a bridge institution.  Upon the stay becoming permanent, it appears that the PCSA Exemptions no longer apply.  Greater clarity would be helpful regarding the interaction between the 1 Day Stay, the permanent stay and the PCSA Exemptions. 
The Jobs and Growth Act received second reading in the House of Commons on October 30, 2012.  It has now been referred to committee for further study.  Hopefully the committees studying Bill C-45 will address these issues before the Jobs and Growth Act becomes law. We will provide an update on this matter as it develops.

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