Canada’s federal insolvency rules are enshrined in two principal Federal statutes – the Bankruptcy and Insolvency Act, RSC 1985 (‘BIA’) and the Companies’ Creditors Arrangement Act, RSC 1985 (‘CCAA’). In addition, there is the Winding-up and Restructuring Act, which specifically governs the liquidation and restructuring of certain types of companies including banks, insurance companies and trust companies, and a number of provincial statutes which also deal with creditors rights.
Liquidations are typically administered under the BIA and reorganisations under the CCAA, but liquidations under the CCAA are not uncommon and the BIA has reorganisation provisions which largely mirror the CCAA. That said, while both the CCAA and BIA can be used for reorganisation proceedings and many of their substantive rules have been harmonised, the almost invariable practice is to utilise the CCAA for medium to large cases since the relative flexibility of the CCAA affords greater latitude of action to the reorganising debtor.
Bill C-55, An Act to establish the Wage Earner Protection Program Act, to amend the Bankruptcy and Insolvency Act and the Companies’ Creditors Arrangement Act and to make consequential amendments to other Acts, was passed in November 2005, and proposes to introduce a new set of key procedural and substantive amendments to the Canadian insolvency rules. The proclamation date has not yet been fixed, and there is some uncertainty as to whether Bill C-55 will be proceeded with as proposed or at all. References have been made to Bill C-55 amendments where appropriate, notwithstanding that they may not come into effect in that form.
A. DOMESTIC FAMILY OF COMPANIES
1. If insolvency proceedings must be commenced for the family of companies, does your law permit a joint proceeding, ie, a single court file, a single judge, a single list of creditors, single notice list, or must the case for each member of the family proceed separately with no practical acknowledgment of the related proceedings?
Although not directly addressed in the Canadian insolvency legislation, there is a general acceptance in practice for a procedurally consolidated filing resulting in a single proceeding presided over by a single judge with a single electronic ‘service list’. Procedural consolidation is common in Canada to the point of being the general rule, and typically requires no more than compliance with procedural rules relating to venue and process. Creditor lists are not generally publicly available in Canadian insolvency proceedings and, apart from the requirement to give notice at the outset to all known creditors, do not enter into the process until a claims process is commenced at which point whether there is a single or multiple list depends on whether consolidation (procedural or substantive) is appropriate. The service list that is available contains the name of all material creditors whose interest has been sufficient for them to retain counsel and request their name to be added to the list.
(a) What if the members of the family are organised under, or operate in, different locations within your country? Can a company from a distant location in your country commence its bankruptcy proceeding where its affiliate is located, if the affiliate has already commenced its bankruptcy proceeding?
Canadian bankruptcy rules do not differentiate based on jurisdiction of incorporation, and any Canadian or foreign insolvent company that carries on business or has assets in Canada can take separate liquidation proceedings under the BIA. As mentioned above, reorganisations can be administered either under the BIA or the CCAA, but a company can only restructure itself pursuant to the CCAA if the total of the claims against it or its affiliated debtor companies exceeds $5m (the proposal provisions under the BIA are available to all companies regardless of the amount of claims).
Jurisdiction of the courts under both the BIA and the CCAA is derived from a similar ‘locality of the debtor’ concept which broadly means, in the BIA context, the principal place where the debtor has carried on business in the immediately preceding year, or where the greater portion of the debtor’s assets are located (BIA, ss 2(1), 43(5)), and, in the CCAA context, (1) the jurisdiction where the head office of the company is located in Canada, (2) the province in which the chief place of business is located in Canada, or, (3) where the company has no place of business in Canada, the province where the assets are situated (CCAA, s 9(2)). Due to the lack of formality associated with procedural consolidation, it is common for all affected affiliates to file in a single proceeding even if the venue chosen is only the proper locality for one member of the group.
If the court is of the view that the affairs of the bankrupt can be more economically administered in another bankruptcy district, it has authority to transfer the proceedings under s 187(7) of the BIA. This is rarely, if ever, invoked in the restructuring context where the debtor’s choice of venue will normally prevail unless found to be abusive.
(b) To the extent your country has different types of insolvency proceedings (such as Chapter 11 reorganisation and Chapter 7 liquidation in the US), do the members of the corporate family all have to proceed under the same type of proceeding?
There is no requirement to distinguish between case ‘types’ under Canadian law, and it is not uncommon for a single proceeding to result in the sale or liquidation of ‘non-core’ assets of subsidiaries and the extensive reorganisation of the parent company. Reorganisation proceedings frequently mutate into de facto liquidation proceedings without any formal change required.
2. Does your law permit, or prohibit, a single administrator/trustee/ receiver to administer the assets and the liabilities of the entire corporate family?
Typically a single party will serve as trustee or receiver for the entire corporate family in bankruptcy, although there is no express requirement that this be the case. Where there are clearly separate or competing interests, separate receivers or trustees may be engaged.
(a) If so, is there a hearing for the court to determine whether the administration by a single party is appropriate? Are secured and unsecured creditors or other parties in interest allowed to object or be heard at such hearing?
A court hearing to determine whether the administration by a single party is appropriate is not generally required in Canada (standing is not subject to strict rules in Canadian insolvency proceedings). Such a hearing could be requested by a party seeking to require the appointment of separate administrators.
(b) What about joint representation by other professionals, such as law firms or accounting or auditing firms?
Typically, professional accounting or law firms are called upon to provide services to all members of a corporate group in bankruptcy, subject to conflicts of interest in which case special counsel may be involved. Depending upon circumstances, special counsel may have a general mandate or be confined to the issue giving rise to the conflict.
3. Does your law encourage or discourage overlapping boards or management teams for separate members of a corporate family?
Even though there is law dealing with keeping fiduciary duties separate, and the sanction of directors who confuse their obligations, it is not general practice in Canada to have separate, independent boards within a single corporate group unless the subsidiaries themselves are public companies in a related group. Canadian law is relatively silent on the topic of overlapping and interlocking directorships for separate members of a corporate family, but it is established principle that company directors will not be relieved of fiduciary duties to one company because they are also appointed to the board of another group company (Canada Business Corporations Act (CBCA), s 122; 820099 Ontario Inc v Harold E Ballard Ltd (1991) 3 BLR (2d) 113). The general obligation of directors or officers to act honestly and in good faith with a view to the best interests of the company includes a duty not to usurp opportunities properly belonging to a corporation, and a duty to avoid or disclose conflicts of duty and interest (Canadian Aero Service Ltd v O’Malley et al [1974] SCR 592, 40 DLR (3d) 371).
With regard to the related issue of nominee directorships, it is established that the duty of nominee directors must be to the company and not to the entity that nominated them (PWA Corp v Gemini Group Automated Distribution Systems Inc (1993) 103 DLR (4th) 609 (Ont CA)). The issue of board composition and nominee directorships during a restructuring was canvassed in Re Stelco [2005] OJ No 1171 in which the Ontario Appeal Court reversed a lower court decision to rescind the appointment of two directors from Stelco’s board. The directors were connected with two large shareholders of the company, and had been removed on the basis that there was a reasonable apprehension of risk that they would not live up to their obligations to be neutral and act in the best interests of the company. Although the Court of Appeal determined that the court’s inherent jurisdiction under the CCAA does not extend to the removal of directors, the decision nonetheless focused on the need to maintain the independence of the board, which must be free of bias. This concern is addressed in Bill C-55, which will amend the BIA and CCAA to allow the court to remove and replace directors of a debtor where the court believes that a director is or is likely to unreasonably impair reorganisation efforts, or is likely to act inappropriately as a director in the circumstances (Bill C-55, s 42).
(a) If the directors of a parent company are not directors of the subsidiary, but they either directly or indirectly manage the affairs of the subsidiary anyway, do your country’s laws render such people de facto or ‘shadow’ directors of the subsidiary?
In Canada, the test to determine whether or not an individual is a director is one of function not one of name, and the courts in Canada have imposed the duties and responsibilities of a director on those who manage the corporation’s business and affairs, whether or not they have been formally elected as a director. There is established case law that once somebody has assumed the fiduciary office of director, they become liable as if they had been formally appointed to that office, and two of the Canadian corporate statutes, the Canada Business Corporations Act (which is a federal act and may be used in all provinces) (‘CBCA’) and the Ontario Business Corporations Act (‘OBCA’), for example, include in the definition of director, a person that is occupying the position of director regardless of what he or she is called (CBCA s 2(1); OBCA s 1(1)). Further, both statutes provide that in the event of a resignation of all directors in an ‘abandon ship’ scenario (which often occurs in the event of an insolvency or bankruptcy), management persons or officers who continue to manage the corporation’s business and affairs can be considered to be de facto directors at law and subject to the liabilities that are imposed on directors generally (CBCA s 109(4); OBCA s 115(4)).
The possibility of being found to be a de facto director is of particular concern to holding companies with subsidiaries in financial difficulty, since it is then that a holding company is likely to exercise management discretion and general decision-making powers in relation to its subsidiary’s affairs. Canadian courts have found that if controlling shareholders (or, for that matter, ‘strangers’) exercise such influence or control over the directors to the point that the directors are considered ‘puppets’ in doing the bidding of the controlling shareholder, liability as a de facto director can attach (eg Standard Trust Co (Liquidator of) v Cattanach (1994) OJ No 3167). On that basis, if the board of the subsidiary simply accepts the decisions of the holding company without independent analysis, the likelihood of the holding company being deemed a de facto director is increased.
(b) Do the duties or responsibilities of officers or directors of a family of companies change when the companies become insolvent? For example does their duty shift from a responsibility to the shareholders to a responsibility to the creditors. What if only one of the companies is insolvent?
In an insolvency situation, directors are potentially personally liable for a wide range of corporate debts including unpaid employees’ wages, vacation pay, source deductions from employee wages, and environmental damages. Directors can also be personally liable under corporate legislation for permitting a corporation to pay a dividend or to repurchase or retract shares when the corporation is insolvent, and the BIA provides that directors are jointly and severally liable for authorising the improper payment of dividends or for ‘reviewable transactions’ between related companies. Some statutes permit a due diligence defence (for example, s 123(4) of the CBCA and some provisions of the Income Tax Act) while others only permit the more restrictive good faith reliance defence (for example, s 135(4) of the OBCA in relation to certain corporate acts and duties). There are also other statutes which impose strict liability in relation to certain offences (for example, the Environmental Protection Act). The period of responsibility is generally six months to one year prior to the directors’ resignation.
In addition to the basic duty to manage the corporation with the care, diligence and skill of a reasonably prudent person in comparable circumstances, directors are required by statute to act honestly and in good faith with a view to the corporation’s best interests. Whether insolvency triggers a shift of the directors’ responsibility from the corporation to creditors was unsettled in Canada until the recent Supreme Court ruling in Peoples Department Store v Wise [2004] 3 SCR 461 in which the court clarified that although the directors’ duty to the corporation includes keeping the corporation financially healthy, directors owe their fiduciary duties and duty of care to the corporation. In exercising their office, directors do not owe duties directly to creditors even when the corporation is in financial difficulty. Peoples Department Store v Wise also clarified the fact that Canadian courts will generally not substitute their own business judgment for that of the directors in the absence of fraud, dishonesty, personal interest or improper purpose, providing the directors act in a manner consistent with their fiduciary duty and duty of care.
It is important to note that the decision in Peoples Department Store v Wise was influenced by the Canadian legislative backdrop granting other types of recourse targeted at providing a possible mechanism for shareholders, creditors or certain other stakeholders to protect their interests from the prejudicial conduct of directors. As such, the board has a duty to bear the interests of creditors in mind when making its decisions. An oppression remedy is available under CBCA s 241(2) and OBCA s 248(2), and creditors of a corporation whose ‘finances deteriorate’ may have a case to bring a derivative action on behalf of the company under, for example, s 239 of the CBCA or s 246 of the OBCA.
Directors may also be held personally liable for operating a company while in a state of insolvency by virtue of the discretion of the court to lift the corporate veil when there is a finding of fraudulent misrepresentation. In NBD Bank, Canada v Dofasco Inc (1999) 46 OR (3d) 514, for example, a creditor succeeded in a claim for negligent misrepresentation against the chief financial officer of Algoma in respect of statements he had made about the company’s financial position. Algoma, which (subsequent to the statements) filed under the CCAA, was then a subsidiary of Dofasco. Further, it is deemed to be a fraudulent act for a board of directors to permit a company to continue in business, incurring liabilities, when there is little or no reasonable basis to expect that these incremental liabilities will be satisfied.
4. Are there rules and do they change regarding members of the corporate family transferring assets among one another (such as by way of loans, capitalisation, other transactions) when the members are insolvent?
The transfer of assets between members of a corporate family may be attacked after an insolvency event in a variety of circumstances. Transactions may be rendered void absolutely or relatively or, in some cases, compensatory payments may be ordered. Under a variety of provincial anti-fraud statutes, the benefit of which may be taken by trustees in bankruptcy, transactions undertaken with the intent to hinder, defeat or delay creditors may generally be set aside without any specific time limit. The BIA has a number of specific provisions which permit ‘settlements’ (gratuitous transfers of property) to be set aside within a year and, further, for a period of up to five years if the trustee can show that the debtor was, at the time of transfer, unable to pay its debts without the aid of the transferred property, or retained a ‘secret’ interest in the property transferred (BIA s 91). Payments or transfers made with a view to prefer one or more creditors may be set aside if within three months of the bankruptcy event (with the intention to prefer being rebuttably presumed) (BIA s 95). The ‘look back’ period is extended to one year in the case of related party transactions (BIA s 96).
In addition, the courts have the right to examine a category of transactions called ‘reviewable transactions’ (BIA ss 3 and 100). Under this rule, the court may examine non-arm’s length transactions involving the bankrupt for a period of one year prior to the bankruptcy event to determine whether the transaction involved the bankrupt receiving fair value. In cases where the bankrupt gave or received ‘conspicuously’ more or less than fair market value (as the case may be), the judge may order compensatory payments to be made by rendering judgment for the difference. It should be noted that this jurisdiction only extends where the transaction was ‘conspicuously’ beyond fair market value.
Proposed amendments to s 30 of the BIA impose restrictions on the ability of a trustee in bankruptcy to sell assets to a party related to the bankrupt without satisfying certain procedural fairness requirements (Bill C-55 s 23). In deciding whether to approve the transfer of assets to a party related to the debtor, the court will need to consider several factors including whether the process was reasonable, the effect of the sale on creditors and whether the consideration is fair and reasonable reflecting an arms’ length transaction.
(a) Are cash sweep procedures allowed, that is, all cash from all subsidiaries is swept out to one account controlled by one of the family entities and then redistributed among the family members to pay bills?
It is common practice in Canada for cash sweep procedures to be implemented, although there may be some restrictions where they are manifestly inappropriate given the nature of the company’s business or due to trust accounting obligations. In Creditors of Penta Stolp Corp (Lien trustee of) v Toronto-Dominion Bank [1992] OJ No 1480 (unreported), for example, the Ontario Court of Justice warned that it was inappropriate for banks to arrange mirror accounting systems or concentration accounts for companies involved in the construction industry or whose business involved the receipt and use of trust funds.
(b) What if the redistribution results in a healthy subsidiary funding the shortfalls in another subsidiary that is losing money?
The governing rules are those governing a director’s fiduciary obligations to act in the best interest of the particular corporation as well as the fraudulent conveyance provisions referred to above.
5. How does your law treat claims of one member of a corporate family against other members of the corporate family?
Provided claims cannot be attacked as a fraudulent or voidable preference or reviewable transaction, there is no law invalidating claims of one member of a corporate family against another, although there may be restrictions on the ability of such claims to be voted in the event of a reorganisation.
(a) Are such claims invalid or unenforceable?
Members of a corporate family are generally entitled to file a proof of claim against a related company in the same manner as an unrelated creditor. Although s 54(3) of the BIA prohibits a creditor related to the debtor from voting in favour of a bankruptcy proposal, related creditors are not otherwise subject to any specific rules or restrictions.
(b) If not, are such claims on equal footing with those of third party creditors, or are they subordinated, or is there other treatment required or permitted under your law?
Unlike in the US where the priorities between creditors can be adjusted in circumstances when it would be inequitable to allow the priorities to continue without some intervention, the Canadian approach is uncertain in this area. Although the BIA does provide for a scheme of priorities under which certain claims are postponed in specific circumstances (BIA, s 136), none of the Canadian federal insolvency laws expressly sanction the doctrine of equitable subordination, nor has a definitive statement emerged from Canadian courts. The doctrine has been rejected outright (in AEVO Co v D&A Macleod (1991) 4 OR (3d) 368), left open for another day (obiter support in Canada Deposit Insurance Corp v Canadian Commercial Bank (1992) 16 CBR (3d) 154 (SCC)), and not commented on (Unisource Canada Inc v Hongkong Bank of Canada (1998) 43 BLR (2d) 226 (Ontario Court of Justice).
Following on from National Bank of Canada v Merit Energy Ltd [2001] AJ No 918 (Alta QB), in which LoVecchio J held that equitable subordination could only be applied in ‘clear cases where demonstrable inequitable conduct [on the part of the claimant] is present’, a recent lower court decision in CC Petroleum Ltd v Allen [2002] OJ No 2203 seemed to herald a change of heart in respect to cases of ‘ubiquitous and rampant fraud’. Although that finding was reversed by the Ontario Court of Appeal, this was because it was held to be unnecessary based on the facts, and a failure by the trial court to conclusively establish jurisdiction to subordinate the claims, rather than because of an outright aversion to the doctrine.
Notwithstanding that there has been no definitive statement as to whether this type of subordination of claim is available in Canada, there does seem to be emerging traction for the doctrine in situations where the statutory priority scheme under the BIA does not apply (for example, where there are competing claims of secured creditors). The Ontario Court of Appeal implicitly supported the application of the doctrine in that context in Bulut v Corpn of the City of Brampton (2000) 48 OR (3d) 108, and equitable subordination was held to be within the jurisdiction of the court (although deemed an inappropriate remedy in the circumstances) in Re Christian Brothers of Ireland in Canada [2004] OJ No 359 (Ont SCJ).
Bill C-55, if enacted, will amend the BIA and the CCAA to effectively subordinate claims of creditors arising in connection with the rescission of a purchase or sale of the debtor’s shares, or in connection with damages arising from their purchase or sale (Bill C-55, s 90).
6. Does your law allow for the pooling of assets and liabilities of all members of the corporate family, so that a creditor of one member becomes, in essence, a creditor of all members?
Substantive consolidation occurs when the creditors of a related group of companies in bankruptcy are all treated as if creditors of the same entity. A very clear distinction needs to be drawn between ‘involuntary’ substantive consolidation and ‘voluntary’ substantive consolidation. It is common to the point of being almost universal practice in large corporate restructuring transactions for a form of ‘voluntary’ substantive consolidation to occur. Where the going concern value of the entire group is being preserved and the creditors are being offered a share in a common pool of consideration (be it money or equity in the new company), they will very commonly vote on a single plan. Where no creditor objects and the creditors are substantially all in common throughout the group, it is even usual to see them vote in a single class. However, where there is any substantial distinction between the identity and amount of claims of creditors at one entity as opposed to another, it is more common to have separate class votes by entity even if the plan is a unified plan common to all entities. As will be seen below, Canadian courts have little precedent and even less statutory foundation for forcing creditors of different entities to be consolidated into a single, substantive proceeding against their will. Procedural consolidation – where the court that controls the restructuring of each of the entities does so in a single, unified proceeding – is all but universal in Canadian restructuring practice and does not in any way entail any presumption of substantive consolidation.
Neither the CCAA nor the BIA have express provisions authorising the consolidation of assets or liabilities of related debtors in bankruptcy or insolvency, but Canadian courts have exercised equitable discretion under both statutes to make such orders in appropriate circumstances. It is generally accepted that a substantive consolidation order is difficult to secure in Canada because it implies dismantling the walls separating the members of the group and putting all of the unsecured assets and liabilities into a common estate. As such, substantive consolidation is generally only permitted in cases where the creditor pools are substantially identical, and provided that it does not result in unfairness to creditors of the separate entities. The leading Canadian case on substantive consolidation is Re Northland Properties Ltd (1988) 69 CBR (NS) 266 (BCSC) in which the court established a test for substantive consolidation that broadly considers three factors namely:
This three-part test for substantive consolidation has not been applied entirely consistently in subsequent cases, with some aspects of it appearing to take on greater or lesser importance. The dominant line of authority would suggest, however, that a Canadian court would consider all of these factors in determining whether substantive consolidation will be allowed.
(a) If so, is such pooling automatic or does it require a factual showing and court involvement?
Typically, court involvement is required if the pooling of assets and liabilities is controversial. As outlined above, the court will take several factors into account, including the difficulty in segregating and ascertaining individual assets and liabilities, the commingling of assets and business functions, the unity of interests and ownership between various corporate entities, the integration and interdependence of the financing arrangements of the affiliated entities and the transfer of assets without corporate formalities, under unreasonable commercial terms or with intent to prejudice creditors. In essence, the fundamental test to be distilled from the dominant line of authority on substantive consolidation is whether the benefits of substantive consolidation outweigh any material prejudice to one or more individual creditors. The courts also consider whether substantive consolidation is fair and reasonable in the circumstances.
(b) What proceedings (motion, request, trial, etc) are required for the court to order the pooling of assets and liabilities?
Where a corporate group is substantially interdependent, CCAA applications are generally made on a consolidated basis in an application made on behalf of each of the companies in the corporate group, and the stay of proceedings generally authorise that the status quo in terms of inter-company operations be maintained. The debtor in a proceeding under the CCAA where there has been procedural consolidation of related entities can propose a plan of arrangement that provides for the consolidation of the assets and liabilities of related entities. If the plan is approved by the appropriate majorities of each class of creditor, and if the court determines that the plan is fair and reasonable to creditors, the assets and liabilities of the restructured entities may be consolidated in the implementation of the approved plan. Courts have in a few cases sanctioned voting classes for such plans that included combined creditors of both debtors. Typically, if consolidation of assets and liabilities is proposed by the debtor company in a restructuring, it will be approved unless opposed, and practice tends to favour substantive consolidation where inter-company claims or guarantees mean that the ultimate result would be substantially the same. Generally speaking, the issue only arises after a plan has been formulated and the court is asked to call a meeting of creditors and to establish the voting classes for creditors.
(c) Does your country’s law contemplate any partial pooling of assets and liabilities?
As indicated, contested consolidation proceedings are rarely seen in Canadian proceedings. In a restructuring, the issue of consolidation is normally only relevant at the stage of classification of creditors. In a pure liquidation, consolidation is a rarity.
(d) If the pooling of assets and liabilities is called for, are there any protections for certain types of creditors, such as creditors with a lien or other security interest in particular assets?
Neither the CCAA nor the BIA allows a plan to be ‘crammed down’ against a dissenting class of creditors. In particular, secured creditors cannot be crammed by the unsecured creditors since both the CCAA and the BIA mandate a classification between secured and unsecured creditors, and require that the plan be approved by all classes of creditors voting separately. Because both the CCAA and BIA require a double majority vote from each affected class of creditors (two-thirds in value and 50% plus one in number) and there is no ability for the court to impose a plan upon a class which has failed to meet this voting threshold, there is a natural reluctance by debtor companies and the courts to authorise fragmentation of creditor classes beyond the mandated secured and unsecured creditor classifications.
Where separate classes of creditors are required in order to deal with the particular attributes of class members, the court applies a ‘commonality of interest’ test in respect of which courts look primarily at each creditor’s rights in relation to the company prior to and under the plan, as well as on liquidation. The interests of various creditors must be viewed purposively, bearing in mind the object of the CCAA to facilitate reorganisations, and courts tend to resist classifications which jeopardise otherwise viable plans (Re Stelco Inc (2005) Carswell Ont 6818 (Ont CA)). Although classification is determined on a case-by-case basis, classes are generally confined to those persons whose rights are not so dissimilar as to make it impossible for them to consult together with a view to a common interest (per Bowen J Sovereign Life Assur Co v Dodd [1892] 2 QB 573).
7. How are secured creditors treated with respect to a family of companies? For instance, if a creditor has a security interest in the assets of one member of the family, and a guarantee from another member of the family, are both such claims valid in insolvency proceedings of the entire family?
Absent extraordinary circumstances, the independent claims of and against each family member are separately proved. Any such claims are subject to the rule against double proof pursuant to which there cannot be two proofs of claim filed for the same debt (Re Olympia & York Developments Ltd (1998) 4 CBR (4th) 189). If the principal debtor and the guarantor both go into bankruptcy, the creditor can prove against both estates for the full amount of the debt, but may not receive more than the total principal amount due, and must account to the guarantor’s estate for any surplus received. If the guarantor pays the creditor in full, it is entitled to prove the claim in the bankruptcy of the debtor (McCrie v Gray (1940) 22 CBR 390 (Ont SC)).
8. Do your laws or courts provide for post-insolvency commencement of new financing that allows continued operation of the business and provides adequate protection to the lender who made the loan? Explain.
Currently, neither the CCAA nor the BIA provides for debtor-in-possession financing. Canadian courts have, however, increasingly exercised their inherent jurisdiction in allowing for the creation of DIP financing, also on a super-priority basis, where this can be shown to be necessary in order to carry out their restructuring. For example, in Re Algoma Steel Inc [2001] OJ No 1943, the Ontario Court of Appeal held that DIP financing will be permitted where it is necessary in the circumstances.
From being unknown only a few years ago, DIP financing has grown to be an almost universal feature of restructuring practice in Canada despite the lack of an explicit statutory framework. While DIP lending arrangements involving the existing operating lender are with few exceptions the rule, exceptions do exist and ‘hostile’ DIP arrangements are no longer unknown. Canadian courts have however used great restraint in approving DIP lending arrangements if there is any opposition to them and will generally restrict them both in duration (usually for not more than the initial 30-day period until an opportunity for a full hearing on notice exists) and in amount until such time as all of the issues can be aired in a general hearing.
Once in effect, Bill C-55 will codify what is essentially existing practice by expressly permitting interim financing under proposed s 50.6(1) of the BIA (Bill C-55 s 36) and s 11.2 of the CCAA (Bill C-55 s 128). In determining whether to grant interim financing, courts will be required to consider a number of factors including the period during which the company is expected to be subject to insolvency proceedings, whether the company has the confidence of the major creditors, whether the loan will enhance the company’s prospects towards a viable plan, the nature and value of the company’s assets and whether creditors will be materially prejudiced.
9. Are directors and officers subject to civil or criminal sanctions if:
(a) Fraud or misrepresentation of a company’s finances are discovered?
As mentioned in question 3(b), directors and officers owe a duty, both at common law and under various provincial Business Corporations Acts to act honestly and in good faith with a view to the best interests of the corporation. Directors acting in good faith and within the scope of their general duties to the corporation are generally protected against personal liability, while there is generally no protection from personal liability in cases of fraud, securities fraud, or fraudulent misrepresentation. Directors have been found liable to creditors for making negligent statements optimistically overstating the financial health of their corporation where those statements have induced the creditor to extend credit or take other actions to its detriment (NBD Bank, Canada v Dofasco Inc, supra).
Further, Ontario recently passed legislation creating a secondary market civil liability regime which allows secondary market investors to sue, inter alia, directors and officers for misrepresentations or failure to disclose in a timely manner (Bill 198, An Act to implement Budget measures and other initiatives of the Government). In contrast to the common law cause of action for negligent misrepresentation which requires each plaintiff to prove that it relied to its detriment on the alleged misrepresentation, Bill 198 creates a statutory right of action without regard to whether the purchaser or seller of securities relied on the alleged misrepresentation.
Finally, under s 198 of the BIA, a bankrupt corporation is guilty of an offence if it, inter alia, makes a false entry or knowingly makes a material omission in a statement of accounting, or, after or within one year immediately preceding bankruptcy, it falsifies or makes omissions in an attempt to conceal the state of its affairs, or obtains credit by false representations. Not only are officers and directors of the corporation subject to liability under the BIA, but also any person who in fact had control of the corporation if they directed or authorised the transaction (BIA s 204).
(b) They allow the company to continue to operate while knowing it does not have the ability to pay the debt being incurred?
Canadian courts are generally respectful of the business judgment of directors and officers in conducting the business of the corporation so long as that business judgment is based on reasonable diligence and is in what the director believes to be the best interests of the company, and provided that the business decisions do not involve fraud or self-dealing. The Supreme Court of Canada endorsed the business judgment rule in Peoples Department Store v Wise, emphasising that decisions of the board ‘must be reasonable business decisions in light of all the circumstances about which the directors or officers knew or ought to have known’.
Although courts have imposed liability on directors towards creditors where they have continued to operate the business knowing of the corporation’s inability to pay the debt incurred, the circumstances in which they have done so are relatively narrow. Liability is generally not imposed outside of situations where directors or officers act fraudulently, in bad faith or take personal advantage, or where they deal directly with creditors in a misleading manner. As mentioned in question 3(b), however, directors and officers of a company that is near insolvency do have a duty to consider the interests of the company’s creditors. If they fail to give appropriate consideration to those interests, they could be found responsible under the oppression remedy or pursuant to a derivative action to the creditors. The directors have to make an informed and reasonable assessment about the prospects of staying in business without going through a formal restructuring. Where there is no reasonable basis for the belief that the company can stay in business, continuing to increase the debts of the company may be unfairly prejudicial to the interests of the existing creditors in which case the resulting loss to the creditors could be placed on the directors or management.
(c) Same as (b) above but the directors believe that if some event occurs (eg chance to obtain new contract in prospect, new equity infusion, or new financing) it will be able to save the company and pay its bills?
As mentioned above, where directors and officers on a reasonable basis determine that a corporation has a reasonable prospect of remaining in business, a court will respect their business judgment and will not find it to be insolvent for purposes of the bankruptcy laws or laws regarding fraudulent conveyances.
B. INTERNATIONAL FAMILY OF COMPANIES
1. If one or more members of the corporate family is incorporated under or governed by the laws of another country, does that change your answers to any of the questions set forth above?
In principle, relief under the BIA or the CCAA is available regardless of whether some members of the corporate family are incorporated or governed by the laws of another country.
However, in practical terms, the efficacy of Canadian orders may be impacted, depending on the availability of comity or ancillary proceedings between the relevant jurisdictions.
2. If insolvency/restructuring proceedings are instituted for corporate family members in different countries:
(a) What controls as to where the case must be filed (eg centre of main interests, principal place of business, location of parent, etc)?
Under the CCAA, Canadian courts have jurisdiction over ‘debtor companies’ with individual (or consolidated) debt exceeding $5m. The key eligibility requirement is found in the definition of ‘debtor company’. ‘Company’ includes any corporation either incorporated in Canada or doing business in Canada (wherever incorporated) with the exception of certain limited categories of corporations such as banks, railway companies, insurance companies and trust companies. Under s 9(1) of the CCAA, jurisdiction is dependent on:
The residency requirement is one which has not tended to be strictly construed by the courts in Canada, holding that corporations with only a small connection to Canada are nevertheless eligible to utilise the CCAA, since such a connection could conceivably be as slight as a bank account or loans contracted in Canada.
Once in effect, Bill C-55 will change the Canadian landscape as regards recognition of foreign proceedings in that it adopts the UNCITRAL Model Law on Cross-Border insolvency concepts of a ‘foreign main proceeding’ and a ‘foreign non-main proceeding’. A ‘foreign main proceeding’ is an insolvency proceeding in a country where a debtor company has the ‘centre of its main interests’, whereas a ‘foreign non-main proceeding’ includes foreign proceedings which are not ‘foreign main proceedings’. In the absence of proof to the contrary, the jurisdiction of a debtor company’s registered office is deemed to be the centre of its main interests. Relief available to the debtor companies will vary, depending on the classification as a ‘main’ or ‘non-main’ foreign proceeding (Bill C-55 ss 122 and 131). Although the impact of this new rule has obviously not yet been tested, it is likely that orders of a foreign court in relation to proceedings which can be classified as a ‘foreign main proceeding’ will be recognised and implemented by a Canadian court (subject to the overarching proviso that they are consistent with the CCAA and BIA).
(b) Do the courts attempt to exercise jurisdiction over the assets of the company filing domestically no matter where located (for example, overseas), or do they limit their jurisdiction to only those assets located in your country?
Both the CCAA and the BIA operate on the assumption of universal jurisdiction, extending authority and duty to control the assets of the debtor corporation wherever located (in Canada or abroad) for the benefit of creditors, wherever located. Neither Act explicitly purports to limit its jurisdiction to assets located in Canada, nor do they purport or attempt to limit the benefit they confer to creditors located in Canada with no distinction based upon the country of origin, or location of assets and creditors.
(c) Would your courts enforce a court order from a foreign country that attempted to exercise jurisdiction over assets located in your country but owned by the company that is subject to the foreign insolvency proceedings?
Traditionally, Canadian courts have been open to the concept of comity and the recognition of properly constituted foreign insolvency proceedings wherever this is consistent with public policy. Generally comity has been extended in the form of co-ordination between jurisdictions rather than a surrender of jurisdiction, with clear statements that the court’s function in this context is not simply to ‘rubber stamp’ orders emanating from the foreign court of the primary bankruptcy. In exercising a discretion to recognise and enforce a foreign bankruptcy order, Canadian courts have taken a variety of factors into consideration including the compatibility of the foreign jurisdiction’s insolvency rules with the Canadian regime.
The implementation of s 18.6 of the CCAA (and its equivalent Part XIII of the BIA) codified the approach taken to comity which had evolved to harmonise bankruptcy proceedings in various jurisdictions. Section 18.6 grants the court authority to make such orders and grant such relief as it considers necessary to implement arrangements that result in a coordination of Canadian insolvency proceedings with foreign proceedings. In presiding over restructuring proceedings recognised as foreign proceedings under the CCAA, Canadian judges have a wide discretion to tailor the terms and conditions of the orders that can be granted in the course of the corresponding CCAA proceedings, and may grant any relief they consider appropriate to co-ordinate proceedings initiated under the CCAA with foreign insolvency proceedings. For example, they can formally recognise foreign orders and provide assistance to foreign representatives in foreign restructuring proceedings provided that such recognition is not inconsistent with the provisions of the CCAA, other Canadian laws or public policy.
The application of s 18.6 of the CCAA was interpreted in the seminal case, Re Babcock & Wilcox Canada Ltd (2000) 18 CBR (4th) 157 (Ont SCJ), which provides a ‘road map’ of considerations for the court in deciding whether to recognise foreign proceedings. In that case, Farley J noted that comity and cooperation between courts was to be encouraged, that the overall thrust of foreign bankruptcy and insolvency legislation was to be respected unless overtly divergent from the Canadian norm, that multi-jurisdictional enterprises should be recognised as one global unit, and that one jurisdiction would assume principal administrative jurisdiction over the reorganisation of the debtor.
As mentioned above under Part B, question 2(a), Bill C-55 (if enacted) will change the approach to recognition by distinguishing between ‘main’ and ‘non-main’ foreign proceedings.
(d) Has your country adopted any procedures (such as the Model Law on Cross-Border Insolvency) to address the various issues that arise in dealing with cases of cross-border insolvency?
Procedural harmonisation has been implemented between courts in the US and Canada through the use of Guidelines Applicable to Court-to-Court Communications in Cross-Border Cases and cross-border protocols, the primary purpose of which are to set out guidelines to coordinate and to promote the efficient administration of cross-border restructuring proceedings. Cross-border protocols are individually negotiated and typically focus on coordination of procedural issues. For example, they might provide that claimants may submit claims for determination in either jurisdiction, and that each court will have jurisdiction over the representatives appointed in its own proceedings although representatives and claimants may appear in either court. There have also been examples of joint hearings under cross-border protocols.
In a further step to promoting co-operation between Canadian and foreign courts in the recognition of cross-border insolvency proceedings, Bill C-55 introduces certain elements of the UNCITRAL Model Law on Cross-Border Insolvency into the BIA and CCAA.
Further, An Act to implement the Convention on International Interests in Mobile Equipment and the Protocol to the Convention on International Interests in Mobile Equipment on Matters Specific to Aircraft Equipment (the ‘Capetown Convention Implementation Act’) received royal assent on 24 February 2005. It amends the BIA and CCAA to restrict the rights of a restructuring debtor to use aircraft assets after the commencement of insolvency proceedings.
