NORTH OF THE BORDER UPDATE
This article has been contributed to the blog by Steven Golick and Martino Calvaruso. Steven Golick is a partner in the insolvency and restructuring group of Osler Hoskin & Harcourt LLP, and Martino Calvaruso is an associate in the group.
The September 18, 2009, amendments to the Companies’ Creditors Arrangement Act (the “CCAA”) relegated equity claims to a subordinate position to claims of unsecured creditors. Prior to these amendments, there was no statutory guidance on the treatment of equity claims under the CCAA. In a recent decision of the Ontario Superior Court of Justice (Commercial List) (the “Court”), Justice Pepall has interpreted those sections in the context of preferred shares and provided guidance as to the analysis that must be done to determine whether preferred shares will be treated as debt or equity claims.
In Nelson Financial Group Ltd., representative counsel for the promissory noteholders of the Nelson Financial Group Ltd. (“Nelson”) sought an order that the claims of Nelson’s preferred shareholders be classified as equity claims, that the unsecured creditors be paid in full prior to any payment towards the satisfaction of a preferred shareholders’ claim, and that the preferred shareholders form a separate class that is not entitled to vote at any creditors’ meeting.
Nelson was in the business of providing credit to its customers in vendor assisted financing programmes. Nelson raised the capital necessary to provide such credit by issuing promissory notes, which carried a 12% annual rate of return, and preferred shares, which generally provided for a 10% annual dividend. Funds were lent by Nelson to its customers at a rate significantly higher than which Nelson paid to its investors. Nelson filed for protection under the CCAA on March 23, 2010. In its eighth report, Nelson’s Court-appointed monitor reported that a plan of compromise or arrangement was being developed. Pursuant to that plan, the existing preferred shares would be cancelled and the holders of such shares would either be entitled to claim a tax loss for their investment or be provided with replacement preferred shares.
The Court briefly summarized the current law regarding equity claims under the CCAA. The Court reviewed the amendments to the CCAA that came into effect on September 18, 2009, which added, amongst other things, the definitions “equity claim” and “equity interest” along with additional provisions dealing with the treatment of such claims and interests. Sections 6(8) and 22.1 of the CCAA provide that no compromise or arrangement that includes the payment of an equity claim shall be sanctioned by a court unless it first provides for the payment of all non-equity claims and that equity claims shall form a class of creditors that are unable to vote at any meeting unless otherwise ordered by a court. The Court was of the view that the amendments to the CCAA incorporated the historical jurisprudential treatment of equity claims. In previous cases (prior to the CCAA amendments), where the instrument in question contained elements of both debt and equity, the courts determined the substance of the relationship between the corporation and the holder of the instrument; the courts were required to examine the parties’ intentions.
With respect to the preferred shares issued by Nelson, the Court held that such shares possessed characteristics attributable to both debt and equity claims. However, the Court noted the following facts as material to the determination as to whether the relationship was one of debt or equity:
- Investors were given the option of investing in promissory notes or preferred shares and the investors decided to invest in the preferred shares. The Court reasoned that if the investors elected to invest in the promissory notes, then the investors would have been creditors of Nelson.
- In accordance with the terms of the preferred shares, the investors holding such shares had the right to receive dividend payments from Nelson. The Court noted that the right to receive dividends is a right that is commonly associated with a shareholder.
- Conditions on the preferred shares provide that upon a liquidation, dissolution or winding-up of Nelson, the preferred shareholders would rank in priority ahead of Nelson’s common shareholders. According to the Court, implicit in such conditions is that the preferred shareholders rank behind Nelson’s creditors.
- Nelson’s financial statements and its books and records classified the preferred shares as equity. This classification was relevant to the Court even though the preferred shareholders had not received copies of such financial statements from Nelson.
The Court acknowledged that an equity claim may at some point become a debt claim. As a result, the Court determined that it must also conduct an analysis of the nature of the claims of the preferred shareholders vis-a-vis the definition of “equity claim” under Section 2 of the CCAA. The Court found that the claims of preferred shareholders were based on either declared but unpaid dividends, unperformed requests for redemption, compensatory damages resulting from the purchase of the preferred shares caused by negligent or fraudulent misrepresentation, and/or the payment of amounts due upon the recession or annulment of the purchase or subscription of the preferred shares. The Court concluded that these claims clearly fell within the definition of “equity claim” under Section 2 of the CCAA and that such claims and their holders were therefore subject to Section 6(8) and 22.1 of the CCAA.
Accordingly, the Court granted the motion of the representative counsel for the noteholders and determined that the holders of the preferred shares: (a) possess claims against Nelson that are “equity claims” under the CCAA, (b) are subordinate in priority to unsecured creditors (and therefore, to the noteholders) and cannot receive any recovery unless all unsecured creditors have been paid in full, and (c) form a separate class that is not entitled to vote at any of the meetings.
Nelson Financial Group Ltd. provides important guidance on what constitutes an “equity claim” and an “equity interest” under the CCAA. Of note, the Court has interpreted the new equity-related provisions of the CCAA in a manner that incorporates pre-amendment case law and is consistent with the historical treatment of equity claims. This decision provides a good roadmap for analysis of potential equity claims when formulating CCAA plans.