Restructuring in Canada

Canada and the U.S.

When it comes to restructuring, while there are many similarities between the Canadian and American systems, there are some material differences in approach and process that must be appreciated. In certain cases, the same words (for example, DIP financing) have quite different meanings or nuances.

As in the United States, insolvency laws in Canada deal with both restructurings and liquidations. In Canada, there are two statutes governing restructurings: the Companies' Creditors Arrangement Act (CCAA) and Part III of the Bankruptcy and Insolvency Act (BIA Proposals). After extensive delay, wide-ranging amendments were proclaimed in force effective Sept. 18, 2009. This paper incorporates a sampling of those amendments, along with a few of the differences you may experience when involved in an insolvency in Canada, particularly under the CCAA.

Cross-border Insolvencies

The existing provisions dealing with cross-border restructurings have been substantially amended. Section 18.6 of the CCAA has been replaced by Part IV ' Cross-Border Insolvencies. Part IV is based on the UNCITRAL Model Law and is very similar to Chapter 15 of the U.S. Bankruptcy Code.

There is a nuanced difference between Part IV and Chapter 15. Under Part IV, the Canadian court must be satisfied that the proceeding to be recognized is a “foreign proceeding.” Once this determination is made, the court decides whether the foreign proceeding is a “foreign main proceeding” or a “foreign non-main proceeding.” Thus in Canada, unlike the Bear Stearns scenario, no foreign proceeding will be refused recognition in Canada. As part of this distinction, there is no requirement for the foreign representative to prove an “establishment' in the foreign jurisdiction. A foreign non-main proceeding is simply a foreign proceeding that is not a main proceeding.

Although not expressly provided for in the CCAA, the practice has developed to appoint an “information officer” to periodically report to the Canadian court and creditors on developments in the foreign proceeding. This practice will probably be continued under the new regime.

The CCAA: A Uniquely Canadian Process

Generally, the CCAA is used for restructuring more complex companies (Air Canada, Stelco, Calpine, Nortel), while smaller or less complex filings can be filed under the Bankruptcy and Insolvency Act, or BIA. Both regimes provide for debtor in possession restructuring under the supervision of the court. The CCAA will undoubtedly remain the process of choice in more complex filings.

In essence, the CCAA provides a general framework for restructuring that includes a stay of proceedings to permit the debtor to file a plan of compromise or arrangement (Plan) with its creditors. Beyond the general framework, the CCAA has very few statutory rules compared with the U.S. Bankruptcy Code, and leaves a tremendous amount of discretion in the hands of the court.

Our American clients tend to find the CCAA process somewhat disconcerting, because the United States Bankruptcy Code provides a rule-based regime where virtually every aspect of a restructuring is regulated. Results are (theoretically) predictable. In CCAA restructurings, there is a great deal of flexibility left to the discretion of the judge shepherding the case. This can be bad in terms of predictability, but can be good in terms of flexibility and innovative solutions. The Canadian approach also seems to encourage more negotiated resolutions, and for this reason, restructurings under the CCAA are usually completed much more rapidly than American restructurings.

The amendments to the CCAA have expanded the provisions of the act from 22 sections to 63. Many practices under the act previously grounded in judicial discretion and inherent jurisdiction, such as the granting of DIP charges and administration charges, are now codified by the amendments. There is concern that codification of these practices will reduce the flexibility that is the hallmark of a CCAA restructuring. Time will tell whether this occurs.

Commencement of the Restructuring Process

A CCAA proceeding is usually started by a debtor seeking an Initial Order. The Initial Order declares that the debtor qualifies for relief under the CCAA. The Initial Order will authorize the debtor to develop and file a plan of arrangement or compromise with its creditors. The application for an Initial Order must be accompanied by a statement indicating the projected cash flow of the debtor and copies of its most recent financial statement. To qualify for an Initial Order, the debtor must be insolvent, have debts exceeding $5 million and be a Canadian company or a company carrying on business in Canada.

On an application for an Initial Order, the applicant must satisfy the court that circumstances exist that make the order appropriate. The court must consider whether the relief is warranted. Initial Orders are generally granted, though in some cases an order may not be made where the prospect of restructuring is hopeless.

The new CCAA amendments codify existing-practice with respect to granting various judicial charges such as for DIP financing or administration expenses. However, the amendments now contain express requirements to give notice if secured creditors are to be affected. In urgent cases, Canadian practice may evolve into a more U.S. style of granting interim orders and then final orders for these charges. This will require a change to existing practice and much more widespread service.

Stay of Proceedings

One of the most important aspects of the Initial Order is the stay of proceedings. The CCAA stay is extremely broad. It commonly stays all legal proceedings as against the debtor and the enforcement of private remedies. A stay under the CCAA cannot, however, restrain a person from calling on a letter of credit that is held by a third party in relation to the debtor, nor does it apply to “eligible financial contracts” (e.g., swaps).

In addition, the stay provides for, in essence, a mandatory injunction requiring suppliers to continue to provide goods and services, provided that there is no obligation on any party to provide goods or services on credit. No party may terminate an agreement with the debtor simply by reason of the commencement of proceedings under the CCAA or that the debtor is insolvent.

The term of the stay in the Initial Order is 30 days. The stay provisions of the Initial Order can thereafter be extended for any duration from time to time, on application of the debtor. The CCAA does not impose limits on the number of extensions that may be granted or on the total duration of the process. On each request for an extension, however, the debtor must establish that it is progressing in its efforts to formulate a Plan and that it is acting in good faith. It is safe to say that most CCAA proceedings do not exceed one year.

The Air Canada filing, which was one of the most complex Canadian restructurings, took 17 months from the Initial Order to the final approval of the Plan. The Canadian process can be substantially faster than the US experience.

Disclaimer of Contracts

The amended CCAA now provides for an express statutory right to disclaim contracts. The new provisions set out a notice process, with access to the court if the disclaimed counterparty objects to the disclaimer (unlike U.S. practice, there is no need to get an order permitting the disclaimer of each contract).

Claims arising from the disclaimer will be dealt with in the Plan. Special protection is provided to executory intellectual property or license agreements. The disclaimer of such contracts will not affect the rights of a counterparty, provided such counterparty is prepared to comply with its obligations.

Previous uncertainty with respect to whether collective agreements can be repudiated is resolved by the amendments. Unlike the U.S. process, a collective agreement cannot be repudiated or amended without the consent of the union. It is anticipated that this clarification will make restructurings within a union environment more challenging in Canada and may drive strategic decisions to file in the U.S.

Assignment of Contracts

Historically, there was no ability under the CCAA to force the assignment of an executory contact (either with respect to real property or personal property) without the consent of the counterparty ' where such consent was required contractually. The amended CCAA now provides a statutory right to assign contracts if a statutory test is met. The test requires evidence that the proposed assignee can perform the contract, that it is appropriate to assign the contract and that all monetary defaults will be remedied. The assignment provisions do not apply to eligible financial contracts, collective agreements or contracts which are not assignable by their nature.

Two notable areas where Canadian restructuring practice varies significantly from U.S. practice are: 1) the role of the “monitor”; and 2) the absence of mandatory unsecured creditors' committees.

As part of the Initial Order, the court must appoint a monitor for the purpose of monitoring the debtor's business and financial affairs during the restructuring. The monitor is usually an insolvency practitioner from an accounting firm. The monitor must be a trustee, licensed under the BIA, and cannot have been the debtor's auditor within the previous two years (without court dispensation).

There is no requirement or provision under Canadian law for an unsecured creditors' committee funded by the debtor. Recently, ad hoc creditors' committees have been organized in larger cases. These committees are generally informal and self-funding. In some cases, however, the debtor has been directed by the court to fund these committees where, for example, the committee represents the interests of former employees or retirees.

DIP Financing

The Initial Order (or a subsequent order) may also provide for DIP
financing. This is one area where Canadian and American lawyers use the same word to describe a similar but somewhat different concept.

Section 11.2(1) of the CCAA now expressly provides for a DIP charge and specifies the test to be applied by the court. In Canada, the DIP lender is usually the pre-filing senior secured creditor and is granted a super priority for the DIP loan ahead of all existing secured creditors. There is no concept of “adequate protection” in Canada. Having said that, the court will be reluctant to grant priming DIP financing in the face of strong objections by secured creditors whose security value will be eroded. As well, the DIP charge cannot secure an obligation in existence prior to the DIP order.

Canadian courts have become sensitive to allowing cross-border DIP facilities to drain value from Canadian assets for the benefit of U.S. creditors. Unless there is a benefit to Canadian entities the courts have been reluctant to allow Canadian entities to pledge their assets to support a U.S. DIP facility.

The Introduction of 'Critical Suppliers'

The amendments have added the concept of a critical supplier into Canadian restructurings. A supplier designated by the court as a critical supplier must continue to supply on existing terms, or terms set out by the court. Post-filing amounts owed to critical suppliers will be secured by a court ordered charge. The change does not cover pre-filing debts. The ranking of this charge is not specified, but will probably be high ranking.

Many CCAA proceedings do not result in a traditional restructuring of the debtor. It is now common for businesses to be sold, in whole or in part, during the CCAA process with the Plan constituting a distribution of proceeds (if there is a Plan at all). There is a perception that more value can be obtained for an enterprise through a sale during a restructuring process than through a sale in a receivership process.

There are also technical reasons why a sale in a CCAA process is preferable. The amendments now codify this existing practice. The interim sale of assets is similar in concept to a sale of assets under Section 363 of the Bankruptcy Code, although the elaborate stalking horse process used in such sales is generally not used in Canada. Recent cross-border cases such as Nortel and Eddie Bauer demonstrate how seamlessly such sales of Canadian and U.S. assets can be coordinated.

The Plan

Generally, the CCAA does not set out guidelines or rules for what can be in the Plan. While it does require the inclusion of some provisions with respect to payment of certain wage arrears and pension contribution arrears in order to obtain court approval, the structure of the Plan is left to the ingenuity of the drafter.

The Plan sets out the classes of creditors and the proposed treatment of each class. Typically, a Plan may propose:

• a cash payment of a percentage of the debt;
• a basket of cash or assets divisible among a class of creditors;
• a partial cash payment up front and a payment in the future on some basis; and/or
• a conversion or partial conversion of debt to equity.

The Plan may contain releases (including releases of directors and non debtor third parties) and injunction/exculpation provision to support the releases.

It can be conditional upon certain events, such as obtaining the exit financing.

Court Approval

If the Plan is passed by the creditors, it must be sanctioned (approved) by the court. Although the court places great weight on the decision of the creditors, the approval process is not a rubber stamp. The court must be satisfied that the Plan is “fair and reasonable.” It is at this stage that creditors that have been “swamped” can take the position that the Plan is not fair and reasonable. The amendments enumerate certain conditions that must be satisfied if the court is to approve the Plan ' such as payment of certain wage arrears and pension obligations.

The monitor must file a report with the court setting out its recommendations with respect to the Plan. That report contains a liquidation analysis in order to demonstrate that the provisions of the Plan are superior to a liquidation.

Stay Familiar, Stay Updated

Hopefully, this article will assist in answering some of your basic questions and will help you identify issues and opportunities in your business dealings. Given the many shifts in Canadian insolvency law in September 2009, it is imperative to keep updated on changes to the restructuring process, particularly as more large companies undoubtedly have difficulty navigating the rough economic waters into 2010.

Aubrey Kauffman is a partner in the insolvency practice of Fasken Martineau, one of Canada's largest law firms. Based in Fasken's Toronto office, Mr. Kauffman has considerable experience in cross-border bankruptcies and corporate reorganizations. He can be reached at [email protected].

Canada and the United States are one another's largest trading partners. The rate of investment by Canadian companies in the United States and American companies in Canada continues to grow. With economies that are joined at the hip, financial downturns in one jurisdiction impact stakeholders in both.

The current economic crisis has amplified this dynamic. Cross-border filings in the manufacturing, forestry, energy and retail sectors are mushrooming. Virtually every significant recent restructuring filing has a cross-border element.

This article is an attempt to familiarize American readers with some of the nuances and new amendments you may encounter if you are involved in a Canadian insolvency situation.

Canada and the U.S.

When it comes to restructuring, while there are many similarities between the Canadian and American systems, there are some material differences in approach and process that must be appreciated. In certain cases, the same words (for example, DIP financing) have quite different meanings or nuances.

As in the United States, insolvency laws in Canada deal with both restructurings and liquidations. In Canada, there are two statutes governing restructurings: the Companies' Creditors Arrangement Act (CCAA) and Part III of the Bankruptcy and Insolvency Act (BIA Proposals). After extensive delay, wide-ranging amendments were proclaimed in force effective Sept. 18, 2009. This paper incorporates a sampling of those amendments, along with a few of the differences you may experience when involved in an insolvency in Canada, particularly under the CCAA.

Cross-border Insolvencies

The existing provisions dealing with cross-border restructurings have been substantially amended. Section 18.6 of the CCAA has been replaced by Part IV ' Cross-Border Insolvencies. Part IV is based on the UNCITRAL Model Law and is very similar to Chapter 15 of the U.S. Bankruptcy Code.

There is a nuanced difference between Part IV and Chapter 15. Under Part IV, the Canadian court must be satisfied that the proceeding to be recognized is a “foreign proceeding.” Once this determination is made, the court decides whether the foreign proceeding is a “foreign main proceeding” or a “foreign non-main proceeding.” Thus in Canada, unlike the Bear Stearns scenario, no foreign proceeding will be refused recognition in Canada. As part of this distinction, there is no requirement for the foreign representative to prove an “establishment' in the foreign jurisdiction. A foreign non-main proceeding is simply a foreign proceeding that is not a main proceeding.

Although not expressly provided for in the CCAA, the practice has developed to appoint an “information officer” to periodically report to the Canadian court and creditors on developments in the foreign proceeding. This practice will probably be continued under the new regime.

The CCAA: A Uniquely Canadian Process

Generally, the CCAA is used for restructuring more complex companies (Air Canada, Stelco, Calpine, Nortel), while smaller or less complex filings can be filed under the Bankruptcy and Insolvency Act, or BIA. Both regimes provide for debtor in possession restructuring under the supervision of the court. The CCAA will undoubtedly remain the process of choice in more complex filings.

In essence, the CCAA provides a general framework for restructuring that includes a stay of proceedings to permit the debtor to file a plan of compromise or arrangement (Plan) with its creditors. Beyond the general framework, the CCAA has very few statutory rules compared with the U.S. Bankruptcy Code, and leaves a tremendous amount of discretion in the hands of the court.

Our American clients tend to find the CCAA process somewhat disconcerting, because the United States Bankruptcy Code provides a rule-based regime where virtually every aspect of a restructuring is regulated. Results are (theoretically) predictable. In CCAA restructurings, there is a great deal of flexibility left to the discretion of the judge shepherding the case. This can be bad in terms of predictability, but can be good in terms of flexibility and innovative solutions. The Canadian approach also seems to encourage more negotiated resolutions, and for this reason, restructurings under the CCAA are usually completed much more rapidly than American restructurings.

The amendments to the CCAA have expanded the provisions of the act from 22 sections to 63. Many practices under the act previously grounded in judicial discretion and inherent jurisdiction, such as the granting of DIP charges and administration charges, are now codified by the amendments. There is concern that codification of these practices will reduce the flexibility that is the hallmark of a CCAA restructuring. Time will tell whether this occurs.

Commencement of the Restructuring Process

A CCAA proceeding is usually started by a debtor seeking an Initial Order. The Initial Order declares that the debtor qualifies for relief under the CCAA. The Initial Order will authorize the debtor to develop and file a plan of arrangement or compromise with its creditors. The application for an Initial Order must be accompanied by a statement indicating the projected cash flow of the debtor and copies of its most recent financial statement. To qualify for an Initial Order, the debtor must be insolvent, have debts exceeding $5 million and be a Canadian company or a company carrying on business in Canada.

On an application for an Initial Order, the applicant must satisfy the court that circumstances exist that make the order appropriate. The court must consider whether the relief is warranted. Initial Orders are generally granted, though in some cases an order may not be made where the prospect of restructuring is hopeless.

The new CCAA amendments codify existing-practice with respect to granting various judicial charges such as for DIP financing or administration expenses. However, the amendments now contain express requirements to give notice if secured creditors are to be affected. In urgent cases, Canadian practice may evolve into a more U.S. style of granting interim orders and then final orders for these charges. This will require a change to existing practice and much more widespread service.

Stay of Proceedings

One of the most important aspects of the Initial Order is the stay of proceedings. The CCAA stay is extremely broad. It commonly stays all legal proceedings as against the debtor and the enforcement of private remedies. A stay under the CCAA cannot, however, restrain a person from calling on a letter of credit that is held by a third party in relation to the debtor, nor does it apply to “eligible financial contracts” (e.g., swaps).

In addition, the stay provides for, in essence, a mandatory injunction requiring suppliers to continue to provide goods and services, provided that there is no obligation on any party to provide goods or services on credit. No party may terminate an agreement with the debtor simply by reason of the commencement of proceedings under the CCAA or that the debtor is insolvent.

The term of the stay in the Initial Order is 30 days. The stay provisions of the Initial Order can thereafter be extended for any duration from time to time, on application of the debtor. The CCAA does not impose limits on the number of extensions that may be granted or on the total duration of the process. On each request for an extension, however, the debtor must establish that it is progressing in its efforts to formulate a Plan and that it is acting in good faith. It is safe to say that most CCAA proceedings do not exceed one year.

The Air Canada filing, which was one of the most complex Canadian restructurings, took 17 months from the Initial Order to the final approval of the Plan. The Canadian process can be substantially faster than the US experience.

Disclaimer of Contracts

The amended CCAA now provides for an express statutory right to disclaim contracts. The new provisions set out a notice process, with access to the court if the disclaimed counterparty objects to the disclaimer (unlike U.S. practice, there is no need to get an order permitting the disclaimer of each contract).

Claims arising from the disclaimer will be dealt with in the Plan. Special protection is provided to executory intellectual property or license agreements. The disclaimer of such contracts will not affect the rights of a counterparty, provided such counterparty is prepared to comply with its obligations.

Previous uncertainty with respect to whether collective agreements can be repudiated is resolved by the amendments. Unlike the U.S. process, a collective agreement cannot be repudiated or amended without the consent of the union. It is anticipated that this clarification will make restructurings within a union environment more challenging in Canada and may drive strategic decisions to file in the U.S.

Assignment of Contracts

Historically, there was no ability under the CCAA to force the assignment of an executory contact (either with respect to real property or personal property) without the consent of the counterparty ' where such consent was required contractually. The amended CCAA now provides a statutory right to assign contracts if a statutory test is met. The test requires evidence that the proposed assignee can perform the contract, that it is appropriate to assign the contract and that all monetary defaults will be remedied. The assignment provisions do not apply to eligible financial contracts, collective agreements or contracts which are not assignable by their nature.

Two notable areas where Canadian restructuring practice varies significantly from U.S. practice are: 1) the role of the “monitor”; and 2) the absence of mandatory unsecured creditors' committees.

As part of the Initial Order, the court must appoint a monitor for the purpose of monitoring the debtor's business and financial affairs during the restructuring. The monitor is usually an insolvency practitioner from an accounting firm. The monitor must be a trustee, licensed under the BIA, and cannot have been the debtor's auditor within the previous two years (without court dispensation).

There is no requirement or provision under Canadian law for an unsecured creditors' committee funded by the debtor. Recently, ad hoc creditors' committees have been organized in larger cases. These committees are generally informal and self-funding. In some cases, however, the debtor has been directed by the court to fund these committees where, for example, the committee represents the interests of former employees or retirees.

DIP Financing

The Initial Order (or a subsequent order) may also provide for DIP
financing. This is one area where Canadian and American lawyers use the same word to describe a similar but somewhat different concept.

Section 11.2(1) of the CCAA now expressly provides for a DIP charge and specifies the test to be applied by the court. In Canada, the DIP lender is usually the pre-filing senior secured creditor and is granted a super priority for the DIP loan ahead of all existing secured creditors. There is no concept of “adequate protection” in Canada. Having said that, the court will be reluctant to grant priming DIP financing in the face of strong objections by secured creditors whose security value will be eroded. As well, the DIP charge cannot secure an obligation in existence prior to the DIP order.

Canadian courts have become sensitive to allowing cross-border DIP facilities to drain value from Canadian assets for the benefit of U.S. creditors. Unless there is a benefit to Canadian entities the courts have been reluctant to allow Canadian entities to pledge their assets to support a U.S. DIP facility.

The Introduction of 'Critical Suppliers'

The amendments have added the concept of a critical supplier into Canadian restructurings. A supplier designated by the court as a critical supplier must continue to supply on existing terms, or terms set out by the court. Post-filing amounts owed to critical suppliers will be secured by a court ordered charge. The change does not cover pre-filing debts. The ranking of this charge is not specified, but will probably be high ranking.

Many CCAA proceedings do not result in a traditional restructuring of the debtor. It is now common for businesses to be sold, in whole or in part, during the CCAA process with the Plan constituting a distribution of proceeds (if there is a Plan at all). There is a perception that more value can be obtained for an enterprise through a sale during a restructuring process than through a sale in a receivership process.

There are also technical reasons why a sale in a CCAA process is preferable. The amendments now codify this existing practice. The interim sale of assets is similar in concept to a sale of assets under Section 363 of the Bankruptcy Code, although the elaborate stalking horse process used in such sales is generally not used in Canada. Recent cross-border cases such as Nortel and Eddie Bauer demonstrate how seamlessly such sales of Canadian and U.S. assets can be coordinated.

The Plan

Generally, the CCAA does not set out guidelines or rules for what can be in the Plan. While it does require the inclusion of some provisions with respect to payment of certain wage arrears and pension contribution arrears in order to obtain court approval, the structure of the Plan is left to the ingenuity of the drafter.

The Plan sets out the classes of creditors and the proposed treatment of each class. Typically, a Plan may propose:

• a cash payment of a percentage of the debt;
• a basket of cash or assets divisible among a class of creditors;
• a partial cash payment up front and a payment in the future on some basis; and/or
• a conversion or partial conversion of debt to equity.

The Plan may contain releases (including releases of directors and non debtor third parties) and injunction/exculpation provision to support the releases.

It can be conditional upon certain events, such as obtaining the exit financing.

Court Approval

If the Plan is passed by the creditors, it must be sanctioned (approved) by the court. Although the court places great weight on the decision of the creditors, the approval process is not a rubber stamp. The court must be satisfied that the Plan is “fair and reasonable.” It is at this stage that creditors that have been “swamped” can take the position that the Plan is not fair and reasonable. The amendments enumerate certain conditions that must be satisfied if the court is to approve the Plan ' such as payment of certain wage arrears and pension obligations.

The monitor must file a report with the court setting out its recommendations with respect to the Plan. That report contains a liquidation analysis in order to demonstrate that the provisions of the Plan are superior to a liquidation.

Stay Familiar, Stay Updated

Hopefully, this article will assist in answering some of your basic questions and will help you identify issues and opportunities in your business dealings. Given the many shifts in Canadian insolvency law in September 2009, it is imperative to keep updated on changes to the restructuring process, particularly as more large companies undoubtedly have difficulty navigating the rough economic waters into 2010.

Aubrey Kauffman is a partner in the insolvency practice of Fasken Martineau, one of Canada's largest law firms. Based in Fasken's Toronto office, Mr. Kauffman has considerable experience in cross-border bankruptcies and corporate reorganizations. He can be reached at [email protected].