April 20, 2016

Insolvency and Restructuring – The Synergies and Challenges of a Canada-U.S. Insolvency Proceeding

The necessity to consider insolvency proceedings that involve both Canada and the United States occurs with increasing frequency as businesses develop cross-border structures that range from the simple to the extraordinarily complex. The requirement to consider insolvency proceedings that involve both Canada and the United States can arise because an all-American business enterprise has suppliers, customers, inventory, a sales office, or even shareholders located in Canada. This requirement can also occur because: (i) a corporate group has subsidiary entities incorporated in both Canada and the United States; or (ii) the decision has been made to locate the nominal head office in Canada with business operations and assets primarily located in the United States. As a result, dealing with the restructuring of an enterprise with both Canadian and U.S. connections can pose unique legal challenges. Canada and the United States have many common legal traditions and fundamental legal principles, but there are nuances in Canadian law that can influence the choice of the main proceeding and be critical to ensuring the process successfully meets the aims of the stakeholders involved.

Crossing the Canada-U.S. Border

There are many options when dealing with an insolvency that includes stakeholders located in both Canada and the United States. One of the first considerations is whether a court proceeding is necessary in a particular jurisdiction in light of the nature of the company’s stakeholders. The range of possibilities with respect to a potential proceeding include: (i) proceedings in one country solely with respect to the local debtors; (ii) consolidated proceedings for all debtors filed in one country, with structuring considerations to avoid proceedings in the second country; (iii) consolidated proceedings commenced in one country with recognition proceedings in the second country; (iv) parallel proceedings with the respective entities filing in each country and a cooperation arrangement between two proceedings; and (v) entirely separate proceedings in each of the two countries. The nature of the debtor company’s stakeholders (for example, government regulators or First Nations interests) may suggest that plenary proceedings in one jurisdiction or another are appropriate. By contrast, cost, administrative, and risk considerations may militate in favor of proceedings in a single jurisdiction. The choice among various proceedings must be carefully considered in light of the nature of the stakeholders and the relevant facts in each scenario.

When considering the appropriate jurisdiction, practitioners must also consider the type of relief available in each jurisdiction. In the United States, the U.S. Bankruptcy Code permits a Chapter 7 liquidation or a Chapter 11 plan based proceeding. In Canada, similar choices exist with: (i) a liquidation under the Bankruptcy and Insolvency Act (BIA); or (ii) a plan proceedings under either the Companies’ Creditors Arrangement Act (CCAA) or the BIA. 

A CCAA proceeding in Canada is the most common restructuring statute used for large corporations and, accordingly, for cross-border filings. A large corporation for the purposes of this statute is an insolvent corporation that owes over C$5,000,000 and has assets, does business in, or is incorporated in Canada. The CCAA generally is considered the more flexible plan process and is therefore the preferred proceeding in many major restructurings. By contrast, the BIA is more commonly used for smaller corporations and is much more detailed and therefore less flexible than the CCAA. An important feature of proceedings under both the CCAA or the BIA is the appointment of a court officer to assist the court. Although the “monitor” in a CCAA proceeding and the “proposal trustee” in a BIA proceeding may add an additional layer of expense, when the debtor company is prepared to work closely with the monitor (or proposal trustee), the court officer often can be helpful in moving the proceedings forward and assisting to help find common ground and compromises among different groups of stakeholders. 

Outside the traditional insolvency statutes, the Business Corporations Act (Canada) and some similar provincial statutes offer corporate reorganization alternatives. Under these corporate statutes, a company can pursue a debt or equity reorganization through a plan of arrangement, which is a less court-intensive proceeding. At times, a plan of arrangement will be combined with a CCAA, receivership, or BIA proceeding to facilitate the reorganization steps. 

Coordinating Canada and U.S. Insolvency Proceedings

When the structure of the corporate debtor group or the location of its assets or creditors involves both the United States and Canada, a choice must be made as to how the proceedings will be structured. Where assets, liabilities, and business locations are entirely separate between the Canadian entities and the U.S. entities, it may be possible to simply carry out separate, parallel insolvency proceedings without coordination. These arrangements may be naturally available as a consequence of a ring-fenced corporate structure, which results in the entities of one country being entirely separate for all purposes, including their funding requirements. In other instances, achieving this status can be done in the planning stages for the insolvency proceeding. A limited number of techniques are available to fully segregate the assets, liabilities, intercorporate arrangements, and funding requirements of an entity in one country or the other. These strategies can result in the ability to carry on entirely separate, noncoordinated proceedings in each of the two countries. 

Where this full segregation or separation is not possible, it will be necessary to consider the various methods of coordinating proceedings between the two countries. For example, the location of the assets or the nature of the stakeholders may suggest that closely coordinated dual plenary proceedings are appropriate. Coordination can be undertaken using cross-border protocols to increase efficiency in the parallel proceedings. The cross-border protocols permit communication between the Canadian and the U.S. courts on common issues. At times, this coordination can include joint, simultaneous motions or trials using videoconference in each of the two jurisdictions. The costs should be weighed carefully when planning for complex proceedings of this nature. 

An increasingly more frequent structure is to have a plenary filing in the United States under Chapter 11, with a recognition proceeding under part IV of the CCAA in Canada. Part IV of the CCAA is a modified form of the UNCITRAL model law and is very similar to a U.S. Chapter 15 filing. Canadian courts have in recent years routinely recognized Chapter 11 filings as a foreign proceeding eligible under part IV of the CCAA.

In a recognition proceeding, the court located in the jurisdiction with the “center of main interests” (COMI) will lead the process in reviewing the debtor’s proposed actions. Under the model law, as implemented in both Canada and the United States, the court presiding over the recognition proceeding follows the principles of comity and reviews the proposed actions for prejudice to local creditors and conflicts with local public policy. Once the court determines that a proceeding is a foreign proceeding, it must determine whether the proceeding is a “foreign main proceeding” or “foreign nonmain proceeding.” A foreign main proceeding is defined in the statute as a “foreign proceeding in a jurisdiction where the debtor company has the centre of its main interests.” The COMI is presumed to be the registered head office of the debtor company, but this presumption can be rebutted. Canadian case law has suggested that the court should examine: (i) the location readily ascertainable to creditors; (ii) the location of the debtor’s principal assets; and (iii) the location of the debtor’s management. The analysis undertaken by the Canadian courts to determine whether a recognition order will be granted, and whether the order will be granted recognizing the U.S. proceedings as a foreign main proceeding (rather than a foreign nonmain proceeding) will involve a practical analysis of those factors, as evidenced by the court’s decision in Re Lightsquared LP, 2012 ONSC 2994.

If the COMI is determined to be the United States, the Chapter 11 proceeding will be recognized as a foreign main proceeding. Under the CCAA, the Canadian court must grant certain limited relief, including a stay of proceedings, and may grant additional relief. Two recent Ontario decisions, Re Xinergy Ltd., 2015 ONSC 2692 and Re Zochem Inc., 2016 ONSC 958, emphasize the need for a Canadian court to review the impact of discretionary relief on Canadian creditors and the potential prejudice to such creditors. If there is disproportionate harm to Canadian creditors, the court is to weigh the principles of comity against the proposed relief when making an order.

One question that remains open is whether a court officer should be appointed in proceedings under part IV of the CCAA. A “monitor” is required by statute in plenary CCAA proceedings, but at this time, part IV of the CCAA does not require the appointment of an equivalent court officer. Nevertheless, in order to assist the court in evaluating the proposed relief, an “information officer” has routinely been appointed. Recent cases in Ontario, including Colt Holding Company LLC, 2015 ONSC 3928 at para. 32 and Caesars Entertainment Operating Company, Inc. (Re), Ontario Superior Court of Justice (Commercial List), Court. File No. CV-15-10837-00CL, January 19, 2015 (unreported), provided for recognition proceedings without the appointment of a court-appointed information officer. To date, the court has not provided detailed guidance on when appointment of an information officer is necessary in a recognition proceeding.

The increased use of parallel proceedings and recognition orders is viewed by many in the insolvency and restructuring bar as a positive step forward to increase coordination and efficiency of the proceedings. In some instances, however, fully separate proceedings may effect a better result for stakeholders in one jurisdiction or the other. In those cases, the separate proceedings (or even restructuring without insolvency proceeding) can and should be considered.

Debtor in Possession Financing

Many debtor companies will require access to financing during the course of an insolvency proceeding. This is known as debtor in possession (DIP) financing or “interim financing.” In Canada, the BIA and CCAA contain provisions that permit DIP financing on a priority basis. DIP lenders are given a DIP charge, often ranking ahead of other secured creditors. There are, however, some significant differences, and some of these differences affect the basis upon which DIP financing might be accessed.

The legislation in Canada provides criteria that the court must take into account when considering the approval of a DIP facility. This includes considering whether a creditor would be materially prejudiced as a result of the priority of the lien (or in Canadian parlance “charge”) that would secure the DIP financing. Section 11.2 of the CCAA also directs the court to consider, among other things: (i) the proposed length of the proceedings; (ii) whether the debtor’s major creditors are supportive; (iii) management of the debtor; (iv) likely potential benefits from the proceedings; (v) the relevant assets; and (vi) the monitor’s report. As a result, although the test does not directly mirror the one applied in the United States, many of the same considerations will be before the court.

Canadian courts considering the approval of DIP financing also will consider whether the DIP charge effectively secures an obligation that existed before the order was made. Although the CCAA is flexible, it does contain some limitations, including a prohibition on granting security for an obligation that arose prior to the financing order. In the United States, a rollup DIP facilitythat is, a financing structure where a DIP loan is used to repay prefiling debt and the DIP lender obtains improved security over that of the repaid prepetition/prefiling financing facilityis not prohibited by statute. The statutory prohibition in the CCAA is a fundamental difference between the restructuring laws in Canada and the United States and must be taken into account in structuring any financing during the insolvency process. Canadian courts have been attempting to fill the gap that may arise as a consequence of the legislative prohibition on rollup financing by providing creative solutions. Recent cases have permitted prefiling debt to be repaid with proceeds realized from accounts receivable postfiling, but have not explicitly granted security. Essentially, the court has permitted prefiling debt to be repaid through postfiling financing so long as the prepetition financing does not explicitly grant security.

Notwithstanding the prohibition in section 11.2 of the CCAA, recognizing the need for cross-border cooperation, Canadian courts have permitted recognition of roll-up financing. In both Xinergy and Colt Canada, the court determined that approval of the DIP facility was appropriate under part IV of the CCAA and necessary to protect the debtor’s property. A debtor seeking to have DIP financing recognized in Canada must still be prepared to demonstrate that there is no material adverse interest with respect to any Canadian interests. Failing that, it will be necessary to engage in a balancing of the principles of comity which would override the effect of the material adverse interest to Canadian interests as a factor in determining whether to approve the DIP financing.

Another issue that frequently requires consideration in a cross-border structure is the guarantee of a U.S. DIP financing by a member of the corporate group located in Canada. A Canadian court may encounter this request in a recognition proceeding or in a coordinated plenary proceeding. Specific consideration must be given to the effect on the Canadian entity as a consequence of providing the guarantee. The Canadian courts generally will look to whether the loan is essential for the corporate group as a whole (including the Canadian entity), and whether it is necessary for the resurrection of the business or the preservation of jobs. If this threshold is met, then consideration will be given to whether the guarantee is appropriate because of the level of integration between the Canadian debtors and the foreign debtors. In Re Smurfit Stone Container Inc., [2009] OJ No 349 (Ont Sup Ct J [Commercial List]), the court, in deciding whether to approve the DIP financing structure which included guarantees by the Canadian entities of the DIP loans to the Chapter 11 debtors, considered the extensive marketing process to obtain the debtor in possession financing with no satisfactory alternative having been secured and the high level of integration between the U.S. and Canadian entities with the result that it was difficult for creditors of the debtor group to distinguish between the U.S. and Canadian debtors. Where there is a full integration of businesses and a clear need for financing in Canada, it may be impossible to secure financing on a standalone basis, and DIP financing with cross-border guarantees may be necessary to the reorganization.

Employee Rights – Severance and Pensions

Employee rights in a cross-border insolvency can be considered a mix of good news and bad news, depending on one’s perspective. Employee obligations and pension liabilities of a debtor company are treated differently north of the border. Canada does not have employment at will, and employees have statutory protection for unpaid wages, termination, notice, and severance. By contrast, the U.S. system provides for a more readily achieved, without payment, termination of employment whether in the course of an insolvency proceeding or otherwise. Pension contributions and their priority also diverge between the two countries. In Canada, the steps required to prime a pension plan funding deficiency are relatively minimal and, in most instances, structures can be achieved to reduce or eliminate risk of a DIP lien primed by a pension lien claim, but the same steps and structure will not permit a DIP lien to prime a statutory lien securing a debtor’s “normal course” pension contributions. Under the ERISA system in the United States, the potential for significant priming claims pursuant to pension underfunding circumstances can be impactful and adversely affect recoveries of creditors in the insolvency proceedings.

The consequence of these differences can affect the willingness of a Canadian court to recognize a U.S. court order in Canada. In many instances, Canadian stakeholders that have businesses or operations in the United States often will respect the U.S. court order or Chapter 11 filing without any type of formal recognition. However, Canadian stakeholders such as employees, unions, or government bodies are less likely to accept and recognize the U.S. court order without Canadian court involvement. Canadian differences in employee entitlements, union collective agreements, regulated pension plans, environmental matters, government licenses, and taxes can also affect the desired structure for the debt reorganization proceedings of a corporate group with assets and operations in both the United States and Canada.

The effect of employee claims can force a decision to undertake restructuring under formal insolvency proceedings rather than by way of an out-of-court restructuring. Employees in Canada generally are entitled to reasonable notice of termination, which creates substantial termination entitlements for employees. As a result, restructuring in Canada that involves significant employee terminations and closures of operations may require a formal bankruptcy proceeding for those Canadian operations. Provincial and federal labor laws also create successor employer obligations with the result that a formal proceeding is unlikely to shed union and other labor-related obligations.

Under Canadian pension and insolvency laws, in certain circumstances upon the winding up of a defined benefits plan, a deemed trust for the deficiency can take priority over a lender’s security, including security held by a DIP lender and approved by way of court process. However, as an example, the provincial lien under the Ontario pension legislation will not achieve priority over a DIP lender, provided the guidelines set out by the Supreme Court of Canada in Sun Indalex Finance, LLC v. United Steelworkers, 2013 SCC 6, are followed by the DIP lender. In Indalex, the court was troubled by the fact that the debtor was the plan administrator, and the debtor and the DIP lender did not provide notice of the court hearing to approve the DIP financing and priming lien to the union representing the members of the pension plan to enable the union to make representations to the court regarding the requested DIP lien priority. The practice in Ontario in the post-Indalex decision era to try to protect DIP lenders is to provide notice to: (i) the union; (ii) the plan members (including employees or retirees); and (iii) the government pension regulator (FSCO). In the event that priming cannot be achieved through notice, the BIA provides for an alternative priorities scheme. Secured creditors should consider whether a change in proceedings (from a CCAA to BIA) will achieve the desired outcome. 

Although Canada has a common law tradition similar to the United States, Canadian insolvency law has developed with its own nuances. It is important for U.S. insolvency practitioners to understand these nuances because they impact the structure of cross-border proceedings and the selection of the appropriate jurisdictions for filing. Although practitioners should continue to look to minimizing costs through streamlined CCAA recognition proceedings in appropriate circumstances, plenary proceedings could continue to be the more appropriate mechanism for restructuring larger corporate groups with meaningful operations and assets in both the United States and Canada in certain circumstances.

Additional Resources

For other materials on this topic, please refer to the following. 

The Business Lawyer        

Corporate Bankruptcy Tourists
By Oscar Couwenberg and Stephen J. Lubbe
Vol. 70 Summer 2015 

Business Law Section Program Library

Insolvency and the Multinational Enterprise (PDF)
Presented by: Business Bankruptcy, International Business Law
Location: 2016 Spring Meeting

What You See May Not Be What You Get When the Deal Goes Bad. Drafting Transaction Agreements to Anticipate Bankruptcy and Insolvency Issues (PDF)
Presented by: Corporate Documents and Process, Business Bankruptcy, Corporate Counsel, Middle Market and Small Business
Location: 2016 Spring Meeting