U.S. Canadian Cross-border Restructurings: What's New? 

publication 

May 2007 - (2007 Lexpert Guide to the Leading U.S./Canada Cross-Border Corporate Lawyers in Canada)

2007 Lexpert Guide to the Leading U.S./Canada Cross-Border Corporate Lawyers in Canada

Insolvency and bankruptcy legislation in the U.S. and Canada share a similar debtor-in-possession focus. There are still meaningful differences in both law and practice, however, that can have an impact on cross-border insolvencies and have given rise to certain challenges in administering cross-border cases.

To the credit of each jurisdiction, the courts have proven to be mindful of the need to have a harmonized approach in cross-border restructurings and have an established history of co-operation. The laws of the two jurisdictions remain sufficiently distinct, requiring those involved in cross-border proceedings to be aware and respectful of the differences.

In Canada, the restructuring of insolvent corporations is primarily accomplished through proposals under the Bankruptcy and Insolvency Act, R.S. 1985, c.B-3 (BIA) and plans of compromise and arrangement under the Companies' Creditors Arrangement Act, R.S. 1985, c.C-36 (CCAA). The CCAA is the legislation of preference for dealing with larger and more complex debtor reorganizations due to its flexibility, the broad discretion exercised by the courts, and the expansive stays of proceedings typically ordered.

Canadian restructuring legislation is governed by far fewer statutory provisions than apply to restructurings under Chapter 11 of Title 11 of the United States Code (Bankruptcy Code). A body of judicial precedent has evolved over the past 20 years that fills in many of the gaps in the existing legislation, giving shape and predictability to reorganizations under the CCAA.

In 2005, legislation introducing reforms to the BIA and CCCA (the amendments) was given Royal Assent. The amendments have yet to become effective and are still being reviewed at the time of writing. The amendments will introduce some changes that will align Canadian law and practice more closely to Chapter 11, as well as others that are more uniquely Canadian. They will affect, but not radically change, Canadian restructurings.

Reforms Making Canadian Legislation More Similar to the Bankruptcy Code

In several respects the amendments are similar in concept to provisions of the Bankruptcy Code. The reforms will:

  • include income trusts within the list of debtors that may qualify for protection;
  • provide statutory authority for debtors-in-possession (DIP) lending and priming liens (but without introducing the adequate protection and other safeguards afforded by section 364 of the Bankruptcy Code);
  • provide statutory mechanisms to terminate and assign many executory contracts, including protections for licencees akin to those afforded by section 365(n) of the Bankruptcy Code;
  • provide federal jurisdiction to make orders ("vesting orders") that transfer title in the debtor's property free and clear of liens, claims and encumbrances as can be done under section 363 of the Bankruptcy Code;
  • result in the creation of public creditors' lists in CCAA cases;
  • result in the claims of equity holders in relation to their equity interests being treated as equity; and
  • provide protection for lessors of aircraft objects similar to section 1110 of the Bankruptcy Code.

As under Chapter 15, the amendments contain provisions dealing with international insolvencies. It is possible that the reforms will incorporate into the CCAA the ability to attack fraudulent conveyances, which today is only contained in the BIA. Unlike the Bankruptcy Code, in a Canadian restructuring there is still no creation of a new estate upon filing, no statutory concept of adequate protection, no cram-down provisions, no provisions akin to section 1113 or 1114 of the Bankruptcy Code, and no provisions for the appointment of committees of unsecured creditors, equity holders or retired employees.

Only in Canada

The amendments introduce provisions that are different from the Bankruptcy Code. These include provisions that would permit a wide range of statutory charges against some or all of the assets of the debtor:

  • in favor of estate professionals such as the monitor and the legal and financial advisors to the debtor, and other "interested" parties (which possibly could include advisors to committees of creditors);
  • in favor of directors of the debtor;
  • for a prescribed amount of wages and vacation pay; and
  • for regular pension plan contributions.

A statutory charge can also be granted in favor of someone held to be a critical supplier who is mandated by the court to continue to supply (albeit with unspecified priority). Even though such charges may prime existing secured creditors, the amendments do not contain provisions relating to marshalling, the use of cash collateral or include an adequate protection concept. The amendments permit the court to appoint a national receiver (upon application of a secured creditor). They also enable a court to order the removal of a director and fill any resulting vacancy.

Recognition of Foreign Proceedings in the U.S.

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 introduced into the Bankruptcy Code a new statutory scheme governing cross-border proceedings. Chapter 15 of the Bankruptcy Code replaces section 304 of the Bankruptcy Code and is the U.S. adaptation of the United Nations Commission on International Trade Law (UNCITRAL) Model Law on Cross-Border Insolvency 1997 (Model Law). It permits foreign representatives to obtain relief from U.S. bankruptcy and other courts, provided that the U.S. court first recognizes the foreign insolvency proceeding as either a "foreign main" or "foreign non-main" proceeding. Interim relief pending determination of the petition is available in appropriate cases (likely being cases that could meet the test for a temporary restraining order (TRO) in a section 304 case).

U.S. case law relating to Chapter 15, including the definitions of the center of main interest (COMI), continues to develop and may be influenced by jurisprudence from the EU and other jurisdictions. A finding that the foreign proceeding is a foreign main proceeding affords certain automatic relief, including a stay of proceeding against the debtor and its property in the U.S. It is not clear what orders a U.S. Bankruptcy Court will be willing to make in the case of a foreign non-main proceeding, i.e. whether such orders will be reminiscent of the preliminary and permanent injunctions granted in section 304 cases. The Bankruptcy Court in In re SPhinX, Ltd. (351 B.R. 103 (Bankr. S.D.N.Y)), having determined the proceeding to be a foreign non-main proceeding, clearly was concerned about granting a TRO in circumstances where such order represented an attempt by creditors of SPhinX to frustrate the appellate process in another bankruptcy case.

Time will tell whether these new provisions will impact on the ability of a subsidiary to file a plenary case in the jurisdiction of its ultimate corporate parent or impair the operation of concurrent plenary cases involving the same debtors in both the U.S. and Canada.

Recognition of Foreign Proceedings in Canada

Section 18.6 of the CCAA is frequently used to give effect to a stay of proceedings in respect of actions commenced in Canada against U.S. Chapter 11 debtors and their property, and in some instances to provide a stay of proceedings in respect of Canadian corporations affiliated with U.S. Chapter 11 debtors. Pursuant to section 18.6, Canadian courts have recognized and given effect to U.S. orders approving of DIP financing and related security, implementing claims processes, rejecting executory contracts and approving plans of reorganization and associated orders.

The amendments introduce new foreign insolvency provisions to the BIA and CCAA. They adopt the concept of a foreign main proceeding, being a proceeding commenced in the COMI. A foreign non-main proceeding is defined as a proceeding that is not a foreign main proceeding (without the Chapter 15 requirement that the debtor have an establishment in the other country).

Revisions recently proposed to the amendments provide that the foreign insolvency provisions will not prevent the court from refusing to do something that is "contrary to public policy." In contrast, the Model Law and Chapter 15 (11 U.S.C. § 1506) each refer to actions "manifestly" contrary to public policy.

The amendments contain a broad provision stating that nothing will prevent the court from applying legal or equitable rules governing the recognition of foreign insolvency orders and giving assistance to foreign representatives that are not inconsistent with the provisions of the BIA or the CCAA. This provision may well provide ample room for Canadian courts to exercise the broad discretion and flexibility evidenced to date in cases under section 18.6 of the CCAA.

Recent Cases

11 U.S.C. § 1506 considered

A Canadian corporation and its affiliates (MuscleTech) were facing numerous product liability and consumer lawsuits relating to the diet supplement ephedra, as well as certain prohormone products alleged to build muscles. In January 2006, MuscleTech commenced a main proceeding under the CCAA (Re MuscleTech Research and Development Inc. (Court File No. 06-CL-6241, Ont. S.C.J). The initial CCAA order contained a stay of proceedings against MuscleTech and certain related and unrelated non-debtor defendants, including retailers who had sold the impugned products (third parties).

MuscleTech also filed petitions for recognition of a foreign main proceeding under Chapter 15 of the Bankruptcy Code in the Bankruptcy Court for the Southern District of New York. An order was granted and extended, effecting a stay of proceedings in favor of not only MuscleTech, but also the third parties, pending the granting of an order recognizing the MuscleTech CCAA proceeding as a foreign main proceeding (Bankr. S.D.N.Y., January 18, 2006, Case No 06-10092). The District Court for Southern District of New York withdrew the reference of the Chapter 15 cases to the Bankruptcy Court, in order that it could directly manage the Chapter 15 cases with related ephedra civil litigation.

MuscleTech, relying on sections 105(a) and 1521 (a) of the Bankruptcy Code, soon after requested the District Court to recognize and enforce a claims resolution order that had been made by the Canadian court requiring all claims against MuscleTech to be proved in Canada. Certain creditors with product liability claims objected, asserting that the Canadian order was manifestly contrary to public policy because the Canadian claims process denied them their constitutional right to a jury trial. In the first Chapter 15 case to consider section 1506, the District Court chose to narrowly interpret the public policy exception. As the Canadian claims process was fair and impartial, the court accorded comity to the claims resolution order on the basis that it provided the same substantive and procedural due process protections as would be available in the U.S., despite the absence of a jury trial (U.S. Dist. S.D.N.Y., August 11, 2006, Case Nos. 06 Civ. 538 and 539).

Canadian Court Approves of Third-party Non-debtor Releases

MuscleTech is the first Canadian decision in which a court determined the appropriateness of a plan and sanction (approval) order that granted releases and injunctions in favor of unrelated non-debtor third parties (who were not officers or directors of the debtor) (2007 CarswellOnt. 1029;notice of motion for leave to appeal served March 7, 2007). MuscleTech's plan was unanimously approved by all creditors with proven claims. The plan contained releases and injunctions in favor of the third parties (non-debtor releases). On the motion to approve the plan, certain parties argued that a plan containing non-debtor releases in favor of solvent retailers and others was not fair or reasonable and should not be approved. The Canadian court disagreed, sanctioned the plan and made a broad order giving effect to the non-debtor releases and related injunctions.

In making its decision the court considered the relative prejudice to various parties that would flow from the plan being approved or not. It rejected the proposition that it did not have jurisdiction to authorize the third-party releases, holding that the granting of such releases was not only fair and reasonable, but absolutely essential as there would be no funding and no plan without them.

On March 1, 2007 the District Court was requested to recognize and enforce the Canadian sanction order, relying on sections 105, 1501, 1507 and 1521 of the Bankruptcy Code, and on the bases that permanent injunctive relief furthers the purpose of Chapter 15, is an appropriate remedy in the circumstances, ensures just treatment of creditors and is consistent with principles of comity that should be accorded to foreign law. It made the requested order, thereby giving effect to the non-debtor releases and related injunctions.

While there is no automatic appeal in Ontario in relation to the order sanctioning the plan, a notice of motion for leave to appeal was served on March 7, 2007.

Asset Sales Transactions and Transparency

Facilitating a co-ordinated sale of assets for an affiliated group of cross-border debtors can have its challenges. Amphenol Corp. v. Shandler (In re Insilco Technologies, Inc., Adv. Proc. No. 05-52403, Bankr. D. Del., September 18, 2006) is a reminder that a U.S. Bankruptcy Court cannot grant an order delivering up title to the assets of a non-party subsidiary of a Chapter 11 debtor "free and clear" of liens. In appropriate cases, Canadian courts will grant a vesting order to facilitate a cross-border sales transaction, provided that the court is not being asked to simply rubber stamp a U.S. order just before the closing. To ensure success, it is important that U.S. debtors seeking sales approval and vesting orders in Canada co-ordinate a complementary Canadian process, one that includes notice to affected creditors, and involves the Canadian court from the beginning (sometimes through a receivership process in lieu of a restructuring).

To the astonishment and chagrin of many U.S. stakeholders, in a Canadian sales process there is very often a cone of confidentiality surrounding the terms of the various bids and the purchase agreement with the winning bidder. There is rarely a stalking horse bidder or opportunity for others to try to top the preferred bid, at a public auction or otherwise. Late bids, even if they are higher, will not be entertained if a process that has integrity and is fair has been followed. The process often moves quickly.

The influence of the U.S. is becoming more pronounced in both cross-border proceedings and domestic Canadian proceedings where there are U.S. prospective purchasers and/or creditors with expectations that a process resembling a section 363 sale process should be followed. This recently became apparent in the CCAA proceedings involving Canadian Calpine entitiesin the context ofa series of motions heard by the Alberta Court of Queen's Bench court in January and February 2007 (ABQB, Action No 0501-17864). Space limitations permit only a brief overview of pertinent facts.

The motions relate to the disposition by one of the CCAA debtors (CCPL), of certain assets (CCPL assets), being long-term management, administration and operating contracts between CCPL and Calpine Power Investment Fund (CPIF) and related entities (fund entities), and partnership units of Calpine Power LP (CLP). The Calpine debtors initially anticipated that the CCPL assets would be unattractive to a third-party purchaser in light of various legal uncertainties relating to valuing such assets and regarding CCPL's ability to assign the contracts. A settlement agreement was entered into between CCPL and the fund entities dealing with the disposition of the CCPL assets and resolving other litigious issues. A motion was scheduled with the Canadian court to approve of the settlement agreement.

Before the hearing, a U.S.-based investor, HCP Acquisition Inc. (HCP),made an offer to purchase the CCPL assets. This party also was involved in a hostile bid to purchase the units of CPIF. Delivery of the offer challenged the premise of the parties to the settlement agreement that outsiders would be unwilling to buy the CCPL assets and fueled complaints by a large number of creditors, principally U.S. bondholders, that the court had not ordered a sales or auction process in respect of such assets. These creditors also complained about the non-public disclosure of the terms of the settlement agreement, such that the only parties receiving details of it were those who signed confidentiality agreements.

The court-appointed monitor was ordered to prepare a report summarizing the HCP offer, comparing it to the settlement agreement (this portion of the report being disclosed only to persons who had signed confidentiality agreements), and making recommendations. The hearing of the motion to approve of the settlement agreement was scheduled for five days later.

Before the hearing, HCP submitted a higher offer. This prompted further outcry regarding the lack of a sales or auction process and the "secret" nature of the settlement agreement. The court responded by ordering an abbreviated sale process, requiring all offers to be received within four days (the deadline). On the fifth day the monitor was to report on the offers received. To appease concerns regarding the lack of public disclosure and address what the court considered minimal requirements of fairness and openness, a summary of the financial provisions of the settlement agreement was to be included in the monitor's report.

By the deadline, offers were received from the fund entities modeled on the settlement agreement, from HCP and a Canadian private equity fund (Catalyst). After the deadline, a deal was reached resulting in the fund entities recommending a sweetened HCP offer to purchase the fund's units. This paved the way for HCP to purchase the CCPL assets without opposition from the fund entities. As part of this process, HCP submitted a new offer (HCP final offer), supported by the fund entities, which was lower than its previous offer. Catalyst clarified its offer, making it higher on its face than the HCP final offer.

The court approved of the post-deadline HCP final offer on January 30, largely on the basis of closing and price certainty and monitor and creditor support (2007 ABQB 49). The court was unwilling to keep open the sales process or approve of the Catalyst offer, notwithstanding Catalyst's efforts during the hearing to demonstrate its offer was the highest.

On February 5, the court was notified that another U.S. party, Khanjee Holding (US) Inc., was bringing a motion in respect of the CCPL assets (Khanjee). As a prospective bidder for CPIF's units, Khanjee had signed a confidentiality agreement that precluded it from participating in the CCAA sales process. It claimed that the sales process followed was tainted and unfair. This prompted a "me-too" motion by Catalyst. Implicit in these efforts was the prospect that if these new offers were considered, or the bidding process reopened, more money would be realized for the CCPL assets.

The court refused to vary its earlier order. In reaching its decision, it noted that Khanjee had signed the confidentiality agreement consensually, and could not complain now about the consequences. Catalyst had previously participated in the sales process and was not to be given another chance. This case underscores that once a Canadian court approves of an offer following a court-supervised sales process, it will be reluctant to vary its order, even in the face of a potentially higher and better offer.

Be Prepared for Differences Between Jurisdictions

It is not clear that lenders, investors, suppliers and other creditors are always prepared for the issues that arise when the laws of another jurisdiction are different from their own. Debt holders in the Sons of Gwalia case unhappily discovered that damage claims by equity holders are not subordinated in Australia to the claims of unsecured creditors, as would be the case under section 510 of the Bankruptcy Code (Sons of Gwalia Ltd. v. Margaretic, [2007] H.C.A. 1 (January 31, 2007)). Until the amendments take effect, there is no statutory subordination of such claims in Canada, although there is judicial support for this result.

Creditors on both sides of the border encountered some unwelcome surprises in the CCAA/section 304 cases involving Ivaco Inc. and related debtors. In Ivaco, the Pension Benefit Guarantee Corporation (PBGC) initially asserted claims of more than US$100 million against not only Ivaco, as a plan sponsor or guarantor, but also against the other CCAA applicants in respect of which Ivaco held a controlling interest of more than 80 percent.

The Employee Retirement Income Security Act of 1974 (ERISA) creates statutory group enterprise liability, making the controlled group of a sponsor of a pension plan jointly and severally responsible for liabilities relating to such plan under certain circumstances. This effectively creates a statutory piercing of the corporate veil among related persons. It is an open question whether these ERISA provisions can impose joint and several liability on members of a controlled group outside the U.S. The PBGC claims raised complex questions of international law, including the extraterritorial application of ERISA. A settlement was reached with the PBGC, as a result of which the issue of whether the ERISA claims are enforceable in Canada was not determined.

In Ivaco, U.S. and Canadian creditors alike remain extremely discontent not yet to have received a distribution from assets sales that occurred more than two years ago. This distribution has been held up in large part due to motions brought in Canada by certain pension parties asserting claims based on statutory deemed trusts and liens created by provincial legislation and other arguments. These parties seek to have the funding deficiencies in the defined benefit pension plans paid from the sales proceeds in priority to the claims of the secured and unsecured creditors of Ivaco.

Stakeholders dealing with U.S. debtors should also be alert to the liens that can be asserted by PBGC in the U.S. against the property of a debtor that is a plan sponsor, as well as that of members of its controlled group, including new legislation that enhances the risks posed by PBGC.

Concluding Remarks

Canada continues to be influenced by developments in the U.S., including the increasing presence of U.S. distressed debt lenders and private equity and hedge funds in Canadian reorganizations.

Whether the proactive and aggressive strategies sometimes employed by such parties will invite increased consideration in Canada of U.S. legal concepts, such as equitable subordination and debt recharacterization, remains to be seen.

Sheryl Seigel is Chair of the Business Restructuring and Insolvency Group practising in the Toronto office of Lang Michener LLP, with an emphasis on cross-border restructurings. She has been recognized as a leading insolvency and restructuring lawyer by Lexpert, The International Who's Who of Business Lawyers, Chambers Global, PLC and others, and is a member of the Insolvency Institute of Canada, ABA, ABI, IWIRC and INSOL International.

Reprinted with permission from the May 2007 issue of the Guide to the Leading U.S./Canada Cross-Border Corporate Lawyers in Canada . (c) Thomson Carswell.