On Friday, February 1, 2013, the Supreme Court of Canada released its highly anticipated decision in Indalex Limited (Re). The ruling stemmed from an appeal of an Ontario Court of Appeal decision that had created commercial uncertainty for financing transactions. The primary issue for lenders was a priority dispute between a court ordered super-priority charge granted to a lender that had provided "debtor-in-possession" (DIP) financing under the Companies' Creditors Arrangement Act (Canada) (CCAA), and deemed trusts under the Ontario Pension Benefits Act (PBA), in respect of wind up deficits in defined benefit pension plans.
The Supreme Court of Canada decision included the following*:These issues will be considered further below, followed by some practical implications of the decision.
- Unanimous confirmation of the priority of a court ordered charge granted in insolvency proceedings under federal legislation over the interests of provincial pension claims;
- Affirmation of the broad scope of a provincial statutory deemed trust over the full value of a pension wind up deficiency if the defined benefit plan has been wound up prior to the time of determination of the priorities;
- Statements regarding the extent to which courts can harmonize the federal insolvency priority regime under the Bankruptcy and Insolvency Act (Canada) (BIA) and priorities under CCAA proceedings; and
- Elimination in these circumstances of the uncertainty introduced by the Court of Appeal in respect of the applicability of equitable/constructive trust remedies to secured claims.
Background
Indalex had obtained creditor protection under the CCAA. In the CCAA proceedings, beneficiaries of two underfunded defined benefit pension plans, sponsored and administered by Indalex opposed a motion to distribute the proceeds from the sale of the company's assets to satisfy a secured claim. The secured claim was a court ordered super-priority charge granted in connection with DIP financing provided to Indalex. It is important to note that in Indalex, there were no secured pre-filing claims in competition with the pension deficiency claim and no bankruptcy proceedings had been initiated by the secured DIP creditors.
The beneficiaries argued that assets of Indalex with value equal to the full funding deficiencies (not just unpaid amounts due to be paid) were deemed to be held in trust pursuant to provisions of the PBA and equivalent proceeds of sale should be remitted to the plans on a priority basis, regardless of the court ordered super-priority of the secured claim. The beneficiaries also argued that there were governance, fiduciary duty and notice issues inherent in Indalex's CCAA process, and the treatment of pension interests therein, that justified the imposition of the equitable remedy of a constructive trust in priority to the secured claim. The CCAA court nevertheless approved the distribution to satisfy the secured DIP claim.
The Ontario Court of Appeal overturned the CCAA court's decision and found that where a pension plan is wound up the deemed trust provisions of the PBA apply to all amounts required to liquidate pension plan wind up liabilities, even if those amounts are not yet due under the plan or the regulations. The Court of Appeal held that the deemed trust amount should be paid in priority to the holder of a super-priority DIP charge over the assets of Indalex, despite the CCAA court order creating the charge specifying that it ranked in priority over trusts "statutory or otherwise". The Court of Appeal also found that Indalex had breached its fiduciary obligations in the course of acting as administrator of the plans (in part through steps taken within the CCAA proceedings). Based on this finding, the Court imposed a constructive trust over Indalex's assets with respect to the wind up deficiencies in the plans, a constructive trust that was senior to the super-priority DIP charge.
Priority of the Court Ordered Super-Priority DIP Charge
The Supreme Court of Canada unanimously confirmed the ability of a Court exercising authority under the CCAA to order a super-priority charge for a DIP loan to prime an interest protected by a statutory deemed trust under provincial legislation such as the PBA. This decision was based upon the doctrine of paramountcy which resolves conflicts between the application of valid and overlapping provincial and federal legislation in insolvency matters in favour of the federal provision.
The Court's reasons specifically referred to the order of the CCAA court that the DIP charge ranked in priority to "all other security interests, trusts, liens, charges and encumbrances, statutory or otherwise." Since it was impossible to comply with both the priority of the PBA deemed trust and that of the DIP charge, the Court held that the DIP charge issued under the federal CCAA was paramount and superseded the provincial deemed trust.
The Scope of the Deemed Trust
A majority of the Court affirmed the expansion of the scope of the provincial statutory deemed trust in the PBA in respect of a pension plan being wound up to include the entire wind up deficiency of the pension plan, even if those amounts are not yet due under the plan or the regulations. In Justice Deschamps' reasons, this finding was based upon statutory interpretation, the broadening scope of the deemed trust protection in the legislative history of the PBA and the remedial purpose of the PBA deemed trust provisions - to protect the interests of plan members.
Application of the BIA Priority Regime in CCAA Proceedings
As noted, Indalex did not involve the consideration of pre-filing secured creditors' rights, there was no bankruptcy process and the issues related only to provincially registered (as opposed to federally registered) defined benefit pension plans. There were, however, some brief comments made by the Supreme Court regarding whether federal paramountcy would apply in any CCAA proceedings if no bankruptcy orders were issued. The effect of these comments, which did not form part of the rationale for the priority judgment, may impact recent judgments, including of the Supreme Court, intended to curtail 'statute shopping' and apply a harmonized interpretation to Canada's two primary insolvency statutes (the CCAA and BIA), particularly in respect of priority entitlements.
No Constructive Trust Imposed
The majority of the Court determined that while Indalex had breached its fiduciary duty as plan administrator, a constructive trust in respect of the plan deficiency was not an appropriate remedy in this case. The application of a constructive trust had been a particularly troubling issue arising from the Court of Appeal decision for financers who generally require a level of predictability of outcome on matters such as priority.
Some Practical ImplicationsI covered the Supreme Court's decision last Friday in my comment, Placing Creditors Ahead of Pensioners. I stated this is an extremely important decision because many Canadian corporate plans are still reeling after 2012, and if companies falter, pensioners will be vulnerable in bankruptcy proceedings.
Following the somewhat unexpected findings of the Ontario Court of Appeal in April of 2011, lenders to businesses with defined benefit pension plans in Ontario often took additional protective measures. These measures included greater due diligence in respect of defined benefit plans, stricter contractual terms in respect of such plans and, in some areas such as asset-based lending, reserving up to 100% of any plan funding deficiency against the availability under the applicable credit facilities. In other cases, access to credit may have been restricted due to uncertainty regarding these issues, including for companies seeking DIP financing in the context of CCAA proceedings.
While the brief, obiter comments noted above may raise concern about the automatic subordination of the pension deficiency deemed trust in any CCAA proceedings, the Court in Indalex did not deal expressly with the ability of a secured creditor to bring a motion to initiate bankruptcy proceedings following a failed attempt to restructure or complete a liquidation under the CCAA – a common and successful tactic used in insolvencies with court approval by secured creditors looking to 'reverse the priorities.' Rather, the Court addressed whether a motion brought by the debtor, Indalex, to permit an assignment in bankruptcy (in part for the purpose of reversing priorities) amounted to a breach of fiduciary duty by Indalex in respect of the plan beneficiaries. As a result, it is likely that prior case law permitting a secured creditor to pursue a motion to lift a CCAA stay and petition a debtor into bankruptcy to reverse priorities is still effective.
With the removal of the equitable remedies aspect of the case, we believe asset-based lenders (ABL lenders) will feel much more comfortable in financing companies with provincially registered (as opposed to federally registered) defined benefit plans in a deficiency position and will not automatically reserve from availability all such deficits. Instead, we expect that ABL lenders will consider whatever uncertainties remain on a case-by-case basis. Those considerations will certainly include a greater likelihood that full cash dominion will be required, and will be required to be continued during any restructuring attempt, in order to ensure that past advances (which cannot be prioritized by a court order in the same manner as DIP advances) will be repaid and all disbursements during the restructuring will enjoy the protection of the DIP order similar to the one included in the Indalex case.
We also expect that lenders will continue to include similar representations, warranties and covenants (including default triggers and prohibitions on wind ups and creating new defined benefit plans) and to take federal Bank Act security wherever possible, as they have been doing prior to the Supreme Court decision.
It is early days yet but, in an insolvency context, we foresee an increased frequency of 'pre-packaged' restructuring plans framed under BIA proposal proceedings at the insistence of the lenders and parties offering interim financing in insolvency cases because the default for a failed restructuring attempt is bankruptcy (and the relatively high likelihood of BIA priorities applying), not a contested lift of stay motion within a CCAA to permit a bankruptcy to ensue to bring BIA priorities into play.
* While perhaps not a direct issue for lenders, the Supreme Court decision gave rise to some uncertainty regarding the relevant time when a plan must be wound up in order for the PBA deemed trust to apply in the context of CCAA proceedings. The Court was unanimous in concluding that the PBA deemed trust for wind-up deficiencies did not apply to the one Indalex pension plan that had not been wound up at the relevant time. However, in our view, uncertainty remains regarding the determination of what is the relevant time when a plan must be wound up in order for the PBA deemed trust to apply in the context of CCAA proceedings and what restrictions may exist on a pension regulator ordering a plan wind-up after CCAA proceeding have commenced. Since the timing of plan wind up can impact the scale of any plan deficiency and the priority of payments in respect of that deficiency, we anticipate further debates in CCAA proceedings in cases where a pension regulator is seeking to order a plan wind up until these issues are clarified.
I also stated that there was an important twist in this decision. In order to avoid abuse, the decision clearly stipulates that the full amount of a pension shortfall at a plan’s windup should be considered a “deemed trust” under Ontario’s pension law. As the second article states, that could push pensioners’ demands further ahead in the line of creditors,but still second to DIP lenders.
According to Diane Urquhart, an independent financial analyst, the Supreme Court of Canada's decision actually benefits pensioners over creditors. Diane was kind enough to provide me with a detailed comment on why pensioners have lost the battle but won the war on the SCC's Indalex decision, however, long-term disabled are buried deeper in the ditch:
The Supreme Court of Canada (SCC) decision referred to as, Sun Indalex Finance v. United Steelworkers 2013 SCC 6 , was one of losing the battle, but winning the war for the pensioners. This new decision buries the long term disabled self-insureds deeper in the ditch.Diane added this on the Osler commentary:
Pensioners Won the War
Pensioners won the war within this recent SCC Indalex decision because the whole pension deficit is now accepted as a deemed trust under the wording of the Ontario Pension Benefits Act. Plus, the deemed trust is a trust, which is defined to be a secured creditor under the Federal Companies’ Creditors Arrangement Act (CCAA.) So the whole pension deficit, being a deemed trust, is now above the unsecured creditors for corporations under CCAA. Before this decision, only the employer contributions owing and not yet paid up to the date of the pension plan wind-up were considered to be in the deemed trust and treated as a secured creditor claim. Previously, the whole pension plan deficit calculated at the time of the plan’s wind-up were ranked lower and treated equally with the unsecured creditors.
Typically, bank loans are secured creditor claims, while the publicly-traded bonds are unsecured creditor claims. Both banks with secured creditor claims and bond owners with unsecured creditor claims at corporations with pension plans that have deficits are now in a weaker position in the event the corporation needs to file for bankruptcy protection under CCAA. Nonetheless, I have done research on this subject and concluded that when pension deficits are given priority over the unsecured creditors, the impact on the bond market as a whole is not significant.
Pensioners Lost the Battle
The Toronto Star Feb. 7, 2013 article entitled, “Worried about your pension if your company goes bust?” was correct in its conclusion that the battle between pension plan deficits and Debtor-In-Possession Financing (DIP financing) was lost. DIP financing is provided by banks and other financial institutions to fund a financially distressed corporation’s operating expense after it has announced its intention to restructure under CCAA. S. 11.4 of the CCAA gives judges the power to assign super-priority for repayment of the DIP financing above the other secured creditors of the corporation. S. 57(4) of the Ontario Pension Benefits Act, and S. 30(7) of the Ontario Personal Property Security Act places the deemed trust above all other provincial priorities over certain assets of the plan sponsor. If the Provincial legislation applied, then the whole pension deficit is above the DIP Financing, which is in conflict with the Federal CCAA that places the whole pension deficit below the special DIP Financing.
The SCC Indalex decision applies the legal principle of paramountcy of federal laws over provincial laws, making the whole pension deficit, as a deemed trust, rank below the DIP Financing. I think this aspect of the SCC Indalex decision is appropriate since the DIP financing is necessary to allow the corporation to survive and avoid being place into bankruptcy where all the assets are liquidated and the cash proceeds are distributed to its creditors. A restructured corporation is a better outcome for all stakeholders including current employees. Lenders would not provide DIP financing without being the first to be repaid in the precarious situation of corporation restructurings.
This SCC Indalex decision does not apply to the Nortel pensioners, since Don Sproule and David Archibald on the Nortel pensioners representative committee, accepted the March 30, 2010 settlement agreement that says the Nortel pensioners agree to be treated equally with the unsecured creditors of Nortel. The whole pension deficit now being a deemed trust equal to a secured creditor claim, would have placed the Nortel pension deficit above the unsecured creditors, had the March 30, 2010 settlement not been signed.
Nortel Pensioners at the Short End of the Stick
Koskie Minsky LLP advised the Nortel pensioners representative committee to accept the March 30, 2010 settlement agreement, even though the same law firm retained by 18 Indalex executives in one of the Indalex pension plans asserted deemed trust claims for the whole Indalex pension plan deficit at the July 20, 2009 CCAA court hearing approving the sale of Indalex’s assets. Sack Goldblatt Mitchell LLP represented the United Steelworkers in this Indalex court case and made the same legal arguments on the whole deficit being a deemed trust. The Supreme Court of Canada adopted the two law firms’ premise that the whole pension plan deficit was a deemed trust on the plain wording of the deemed trust sections of the Ontario Pension Benefits Act, words already there at July 20, 2009. It is unusual that a law firm would be taking two different legal positions for two different pensioner groups at the same time. Nortel pensioners have received the short end of the stick on this one.
Long Term Disabled Self-Insureds Left Unprotected by Ontario Government
The creditor claims of long term disabled insureds, who are covered by employer sponsored, or self-insured, disability benefit plans, now have a priority that is below Ontario pensioners in CCAA proceedings. The creditor claims of long term disabled insureds in this situation are unsecured creditors, at the bottom of the list of creditors in CCAA proceedings.
Instead of protecting the disabled, the Ontario Government is facilitating the supply of unsafe disability insurance by employers:
1. The Ontario Government’s Insurance Act explicitly exempts the requirement for insurer licensing of a corporation that has a fund for making payments on the happening of death, sickness, infirmity, casualty, accident, disability or any change of physical or mental condition; or, provides an insurance in connection with the corporation.
2. The Ontario Government refuses to enforce the Ontario Consumer Protection Act to prevent deceptive or misleading representations of disability insurance and related services supplied by employers and administrative services only (ASO) insurers. The reasons for enforcing this Act to provide a regulatory remedy for the Nortel disabled’s poverty caused by corporate wrongdoings are as follows:
i. the plain meaning of the words of consumer and consumer transactions defined in this Act do give jurisdiction for this Act (For example, the Nortel long term disabled insureds bought disability insurance supplied by their employer to raise their coverage from 50% to 70% of their pre-disability income rather than purchasing disability insurance from a licensed insurer, reasonably expecting that Nortel used their money to buy disability insurance from a licensed insurer and expecting Nortel’s disability insurance to be safe even after being told that Nortel plays a role similar to that of an insurance company for its employees.)
ii. the disability insurance supplied by employers and ASO insurers is not on the long list of exemptions for application of this Act)
iii. the Explanatory Notes on the Legislative Assembly of Ontario website indicate this Act is to apply to all consumer transactions, subject to limited exceptions
iv. Hansard transcripts of Ontario Legislature debates on this Act document the legislative intent for a broad and flexible scope of the Act
v. the Act has an Anti-Avoidance clause that applies says a court or other tribunal shall consider the real substance of the entity or transaction and in so doing may disregard the outward form
3. The Ontario Government has no work in progress to require that Ontario based employers who offer disability income benefits to buy disability insurance from licensed insurers. The Federal Government has made this a new requirement for Federally regulated corporations within the Canada Labour Code through Bill C-38 Mandatory Disability Insurance at Federal Employers , which went into force on June 29, 2012.
My reading of the Osler commentary is that the secured lenders have the right to force a bankruptcy under the BIA, which places the Ontario-based pension deficit below the secured lenders, unlike what is the new situation within the CCAA for secured claims to be equal to the pension deficit claims in a deemed trust. If a restructuring or liquidation started in CCAA, the secured lenders would seek to transfer the court proceeding to be under the BIA. . Also, with the so-called pre-packaged restructuring under CCAA, I think Osler is saying the restructuring proposal would contain the threat to have a liquidation under the BIA as an alternative to the restructuring, where the BIA has a more favourable ranking of the secured creditors over the pension deficit claims.
Nonetheless, I still think that the whole pension deficit being considered a deemed trust equal to secured creditor claims under the CCAA is a big win. Hopefully, the judges will see through the gaming of legislation shopping between the CCAA and BIA and make their decisions accordingly and for the protection of vulnerable seniors. This would be most applicable in the case of liquidations, where there is simply an allocation of money going on and not an expedient effort to restructure the business as an ongoing concern.
Corporations should be forced to pick a route of CCAA or BIA and suffer the consequences, and do not have the choice of the best of both worlds.I think one of the main reasons why lock stock and barrel sales of businesses, such as Nortel, have been done under CCAA and not BIA, is because there is a greater capacity to pay post CCAA filing executive retainer bonuses. If the CCAA is picked for this reason, then the corporations cannot be in CCAA to benefit the executives and then transfer to the BIA at the end to benefit the bankers, all the while taking estate dollars away from the pensioners.I thank Diane Urquhart for sharing her insights on this important legal decision. She may be right, pensioners have lost a battle but won the war following the SCC's Indalex decision.
Of course, the bank lobbyists are working feverishly hard to water this decision down and as you read in the Osler legal update above, there is some uncertainty regarding the relevant time when a plan must be wound up in order for the PBA deemed trust to apply in the context of CCAA proceedings.
Diane also sent me an interesting article on how UK pension plan tops Kodak's creditor list, showing how Kodak is on the hook to its foreign plans for $1.2 billion. Bottom line is other countries protect pensioners a lot better than we do in Canada.
In my opinion, the ultimate war on pensions is still raging and will only be won once we separate pensions from companies and enhance CPP and QPP so everyone can retire in dignity and security. All these legal proceedings wouldn't be necessary if Canada treated pensions like it treats education and health care.
Below, John Ehrhardt, Milliman principal and consulting actuary, on the record number of pensions being underfunded. Of course none of this was discussed in last night's State of the Union address (watch below).