Restructuring

NORTH OF THE BORDER UPDATE

This article has been contributed by Martin Desrosiers and Julien Morissette. Martin Desrosiers is a partner in the insolvency and restructuring group of Osler, Hoskin & Harcourt LLP, and Julien Morissette is an associate in the group.
In a judgment rendered earlier this year, Maisons Marcoux Inc. (Syndic de), the Québec Court of Appeal rendered its first decision on the propriety of using the doctrine of marshalling in Québec’s civil law system in over 30 years. While it refused to apply the common law doctrine, it applied a rule of the Civil Code of Québec (CCQ) which arguably lead to a similar result.
Maisons Marcoux was a residential real estate developer which obtained protection pursuant to an Initial Order rendered under the federal Companies’ Creditors Arrangement Act (CCAA). Maisons Marcoux’s first-ranking secured creditor, Caisse Desjardins du centre de la Nouvelle-Beauce (the “Caisse”) was owed approximately $3.3 million, secured on all assets. As part of the attempted restructuring under the CCAA, it provided an additional $2.2 million DIP (debtor-in-possession) loan, secured by a Court-ordered superpriority charge.
The restructuring failed. Maison Marcoux’s assets were liquidated. A portion of the assets, known as the “Boisbriand Project,” were subject to various construction hypothecs amounting to $1 million, registered by contractors having provided various services in connection with the development (the Builders). In Québec law, the general rule is that a construction hypothec ranks ahead of a contractual security.
The Boisbriand Project’s liquidation yielded $1.2 million, compared to $5.8 million for all assets. The trustee in bankruptcy sought to distribute the Boisbriand proceeds as follows:

• Liquidation fees: $190,000
• Directors’ & officers’ (D&O) charge: $110,000
• Caisse, as DIP lender: $900,000
• Builders: $0

The Builders contested this distribution, alleging that they should rank ahead of the DIP lender. The trial judge agreed, and the Caisse appealed.
The judges on appeal agreed that the DIP loan was to be paid in full, from the products of sale taken as a whole. The key question, however, was how to allocate it between the Caisse (in its capacity as secured pre-filing lender) and the Builders. The Court resorted to a little-known, and verbose, article of the CCQ:

2754. Where later ranking creditors are secured by a hypothec on only one of the properties charged in favour of one and the same creditor, his hypothec is spread among them, where two or more of the properties are sold under judicial authority and the proceeds still to be distributed are sufficient to pay his claim, proportionately over what remains to be distributed of their respective prices.

The trial judge had granted all proceeds of the Boisbriand Project ($900,000 net of sale costs and the D&O charge) to the Builders, with an according shortfall for the Caisse. The Court of Appeal reversed this order, noting that the Boisbriand Project had also benefited from the DIP loan to the tune of approximately $1 million. Nonetheless, the Court also clearly stated that the pre-filing loan ‘bootstrapping’ operated by the initial distribution was improper.
On the basis of a 1979 precedent, the Court refused to apply the common law doctrine of marshalling. However, it reached an arguably similar result by applying the middle-ground approach of article 2754 CCQ:

• Liquidation fees: $190,000
• D&O charge: $23,100
• Caisse, as DIP lender: $462,000
• Builders: $524,900

The Court reasoned as follows: the gross proceeds from the Boisbriand Project were $1.2 million, 21% of the $5.8 million grossed overall. It was thus for the Builders to support 21% of the $2.2 million DIP loan and also 21% of the $110,000 D&O charge, with the Caisse as pre-filing lender supporting the balance of the DIP loan.
The parties did not seek leave to appeal to the Supreme Court of Canada and this judgment is now final. The Court of Appeal’s approach is at first sight quite simple, even mechanical. Yet the judgment is couched in equitable terms and an evaluation of the parties’ contribution – similar to what would be expected when the marshalling doctrine is applied.
This case highlights the usefulness of inter-creditor agreements reached in advance, where possible. It appears unlikely that this would have been possible with the Builders on the facts of this case, but fortunately pro rata apportionment was relatively straightforward. However, it is easy to imagine scenarios where article 2754 CCQ would not apply, even by analogy. In addition, for larger corporations, the lending profile is generally much more complex – replicating the Court’s calculations in this case for a multi-entity structure, with inter-company financing and several layers of debt, could prove very difficult, or even impossible.
Another interesting question is whether a party could request that a court acting under the CCAA or the Bankruptcy and Insolvency Act derogate from this legislated version of marshalling. Acting under paramount federal law, a bankruptcy court may have the power to set aside the application of article 2754 CCQ, presumably in favour of the common law doctrine. For the reason given above, this could be necessary in a large bankruptcy, but how explicitly a court would be willing to recognize it remains an open question.

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