This article has been contributed to the blog by Andrea Lockhart and Steven Golick. Steven Golick is a partner in the insolvency and restructuring group of Osler, Hoskin & Harcourt, LLP, and Andrea Lockhart is an associate in the group.

Receivers and their counsel are cautioned to take note of the recent October 3, 2011 decision of the Ontario Superior Court of Justice (Commercial List) (the “Court”) in the receivership proceedings of Skyservice Airlines Inc. (“Skyservice”), in which the Court awarded costs against the Receiver in connection with its failed motion to obtain assets for the benefit of the company’s creditors as a whole.

In this case, the Court heard a dispute between the Receiver and certain former shareholders of a predecessor of Skyservice (the “Shareholders”).  The issue was centered on dispute in connection with the entitlement to certain escrow funds under an Arrangement Agreement.  A predecessor of Skyservice had purchased all of the Shareholders’ interests in such company (the “Shares”) under a series of corporate transactions which resulted in the formation of Skyservice. A portion of the purchase price for the Shares was placed in escrow, to be released to the Shareholders following closing in the event that certain financial thresholds were met. If such financial thresholds were not met, the escrow funds were to be released to Skyservice.

Prior to the Receiver’s appointment, the Shareholders and Skyservice were embroiled in a dispute relating to one such financial threshold – the amount contributed by one of Skyservice’s customers to Skyservice’s EBITDA. The dispute arose from the interpretation of a clause in the Arrangement Agreement relating to the EBITDA calculation, and the importance to be ascribed to the views of Skyservice’s auditors relating to such calculation:

 “…the parties agree, acting reasonably, to determine the applicable EBITDA on the basis of internally generated financial statements for the applicable periods and which are reviewed by [Skyservice’s] auditors.”

The dispute had not yet been settled at the time of the receivership proceedings and related to a rather substantial sum of $1 million plus interest. As a result, the Receiver brought a motion before the Court to determine the proper interpretation of the foregoing clause. The Receiver was of the view that the clause was ambiguous and that accepted principles of interpretation required EBITDA to be determined by Skyservice’s auditor. The Shareholders asserted that the provision was not ambiguous and that the parties were to agree, acting reasonably, as to the determination of EBITDA after the auditors had reviewed Skyservice’s internally generated financial statements. Ultimately, the Court accepted the Shareholders’ interpretation of the clause.

Accordingly, the Receiver requested further relief from the Court, based on the Court’s inherent jurisdiction, in the form of an order that no claim could be brought against the auditor if the auditor’s report was released. The Court held that it had no jurisdiction to make such an order, as the scope of inherent jurisdiction was limited to controlling the court’s own process or administering justice in a regular, orderly and effective manner. Even if it did have the jurisdiction, the Court held that it would decline to make such an order, noting that:

  1. the engagement letter prepared and signed by the auditor provided for a release by Skyservice of any claim against the auditor in excess of fess charged;
  2. the auditor knew the purpose of the work was to assist in the settlement of the dispute, and did not request a release from the Shareholders at that time;
  3. although the engagement letter was not signed by Skyservice, it knew that the auditor was acting under it such that there was likely a contract between Skyservice and the auditor that required the auditor to deliver its report without any release from the Shareholders; and
  4. the Shareholders had no means of knowing whether they would have any complaint against the auditor as they had no knowledge of the work performed by the auditor.

Notably, the Court ordered that the Shareholders were entitled to their costs on the motion despite the Receiver’s assertion that the long-standing convention on the Commercial List and other courts hearing insolvency proceedings was not to award costs in CCAA proceedings and that such rationale should similarly apply to receivership proceedings. The Court noted that there was no such long-standing convention in receivership proceedings and that there were fundamental differences between a CCAA proceeding and a typical receivership involving liquidation. In addition, the Receiver had requested costs in the event that it was successful on the motion, and as such, it would be unfair to the Shareholders if the Receiver were not required to pay costs if unsuccessful.

Accordingly, before commencing proceedings to recover assets for benefit of the creditors, court appointed receivers should carefully consider the risks inherent in such litigation, and factor into the decision the possibility of costs being awarded in the event they are unsuccessful.  While in this case the costs will come out of the funds in the hands of the receiver from the realization of other assets, there may be situations where that is not the case.

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