Restructuring

NORTH OF THE BORDER UPDATE

This article has been contributed by Martin Desrosiers, a partner in the Insolvency and Restructuring Group of Osler, Hoskin & Harcourt LLP, and Julien Morissette, an associate in the Group.

Insolvency courts have broad powers to facilitate a restructuring under the Companies’ Creditors Arrangement Act (CCAA). However, the exact extent of these powers continues to be the object of debate. In a recent judgment, the Superior Court of Québec temporarily revived a commercial distribution agreement to facilitate the sale of a retailer, despite the agreement’s prior termination by the manufacturer. Proceedings are continuing, and the permissible extent of specific performance orders rendered under the CCAA remains to be tested.

The main business of a Québec-based equipment retailer (Retailer) is distributing equipment supplied by a large North American manufacturer (Manufacturer). The relationship between the parties, including their predecessors, goes back over 50 years. In 2009, the Retailer and Manufacturer amended the distribution agreement (Agreement) to set sales targets for the Retailer’s activities.

In the three years that followed, the Retailer repeatedly failed to meet the sales targets for nearly all product lines. The Manufacturer advised the Retailer it was in default of the Agreement and, by late 2012, it became apparent that the only solution would be the sale of the Retailer’s business. The Agreement is clear that any sale would need the Manufacturer’s approval. Two offers were received in February 2013. The highest offer would have allowed for repayment of all Retailer creditors, with some equity remaining for shareholders.

The high offeror was unable to meet the equity ratio required by the Manufacturer to approve the transaction and certain other conditions. Negotiations did not come to fruition and, on March 28, 2013, the Manufacturer terminated the Agreement (the Notice of Termination). A few days later, the Retailer filed a notice of intention to make a proposal to its creditors under the Bankruptcy and Insolvency Act. On April 11, 2013, it filed an application to obtain an Initial Order under the CCAA and continue the proceedings under that Act.

In addition to the usual relief sought under the CCAA, the Retailer requested an order from the Court to suspend the effect of the Notice of Termination. The Retailer pleaded that the termination was untimely and that such an order would facilitate the sale of its business as a going concern because the Agreement was its main asset.

Following a three-day hearing, Justice Lalonde of the Superior Court of Québec agreed to grant the relief sought by the Retailer, on an interim basis. From the outset, he stated it was too early to rule on the merits of the Notice of Termination. Given that this was a new issue under the CCAA, he applied the criteria applicable to safeguard orders in civil matters to determine whether the relief should be granted.

Before the Court delved into the civil criteria, it reviewed the breadth of an insolvency court’s inherent jurisdiction under section 11 of the CCAA, which states that, in general, a court may “make any order that it considers appropriate in the circumstances.” Principally on the basis of case law from other Canadian provinces, Justice Lalonde held that an order affecting third-party rights may be appropriate if it furthers the CCAA’s goal – that is, to facilitate arrangements with creditors and allow businesses to continue operating. As for preserving the status quo while proceedings are ongoing, he added that “the general interest of the mass of creditors (…) is a priority when it comes to balancing opposing interests.”

Having reviewed the facts, Justice Lalonde found that the requirements for a safeguard order were met. His analysis was driven by his view that the inconvenience for the Manufacturer of having to continue dealing with the Retailer was outweighed by inconvenience for the Retailer, its sale process and its creditors.

On the question of whether specific performance could be ordered, the Court cited two cases in which the Superior Court granted similar orders. One was a safeguard order rendered outside the insolvency context, and the other one was included in an Initial Order rendered under the CCAA, apparently in the absence of any contestation. Justice Lalonde granted the suspension of the Notice of Termination using similar terms and ordered the Manufacturer to continue to abide by the Agreement.

The Manufacturer sought leave to appeal this portion of the Initial Order under section 13 of the CCAA. In a judgment rendered on May 10, 2013, Justice Bich, sitting alone, identified the key question of law:

[C]an a judge acting under s. 11 CCAA order the cancellation of a notice of termination and order the specific performance of such an agreement, even as a safeguard measure? (…) The question is undoubtedly interesting as it deals directly with the nature and extent of s. 11 CCAA and the powers vested in the courts to reengineer the contractual relationships of a debtor company. It is also a question that has never been addressed by our court nor, apparently, by other courts of appeal in Canada.

Justice Bich noted that prior judgments rendered by the Québec Court of Appeal in civil matters suggest that it is doubtful that a judge can suspend the termination of an agreement and order its specific performance and that the same doubt exists in common law provinces. The Court added that it is equally doubtful whether such power exists under the CCAA. However, she denied leave to appeal for reasons of expediency and because, from a procedural standpoint, the suspension of the Notice of Termination could soon be revisited by the Superior Court.

Proceedings have since continued before the Superior Court. In the context of an ongoing sale process, on May 16, 2013, the Court extended the suspension until June 28, 2013. The questions of law highlighted above remain unresolved.

There has been a growing trend for insolvency courts to issue orders affecting third parties in CCAA proceedings. These orders have ranged from releases for the benefit of third parties in the context of a plan of arrangement to specific performance orders intended to facilitate restructurings, as here. No one disputes, however, that there are procedural and constitutional limits to the extent of such orders. It remains to be seen whether this attempted restructuring will give a court an opportunity to shed some light on the matter.

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