On February 1, 2013, the Supreme Court of Canada (SCC) released its highly anticipated decision in Indalex Limited (Re).1. 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)2. and deemed trusts under the Pension Benefits Act (Ontario) (PBA)3. in respect of wind-up deficits in defined benefit pension plans.

The issues directly considered in Indalex also concerned defined benefit plans under the Ontario PBA. Different results may follow with regard to federally regulated plans or plans under some other provincial legislation.

Background

Indalex had obtained creditor protection under the CCAA. In the CCAA proceedings, beneficiaries of two underfunded defined benefit pension plans that were sponsored and administered by Indalex opposed a motion to distribute the proceeds from the sale of the company’s assets to satisfy the super-priority DIP 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 under provisions of the PBA and that 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, which 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.

In a decision that surprised finance, insolvency and pension lawyers, the Ontario Court of Appeal overturned the CCAA court’s decision and found that when 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). On the basis of 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.

The decision of the SCC could be described as a mixed result for the lending community with respect to pension deficits. While greater clarity has been provided in some areas, lenders must still be attentive to borrower obligations under defined benefit plans. Here is an overview of the conclusions of the SCC on the major issues for financing transactions.

1. Priority of the Court-Ordered Super-Priority DIP Charge

Based upon the doctrine of paramountcy, which resolves conflicts between the application of valid and overlapping provincial and federal legislation in favour of the federal provision, the SCC confirmed the authority of the court in a CCAA proceeding to grant super-priority status to DIP charges, including over the provincial deemed trust noted in item 2, below.

2. The Scope of the Deemed Trust

A majority of the SCC affirmed the expansion of the scope of the provincial statutory deemed trust in the PBA regarding a pension plan being wound up. That deemed trust would now include the entire wind-up deficiency of the pension plan, even if those amounts are not yet due under the plan or the regulations. Following the reasoning of the SCC, the same interpretation might be given to other provinces’ pension legislation. This expansion of the deemed trust to the entire wind-up deficiency has been a significant issue in many financing transactions that have followed the SCC decision.

3. 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. The Supreme Court did, however, make some brief comments regarding whether federal paramountcy would apply in any CCAA proceedings if no bankruptcy orders were issued. These comments, not forming part of the rationale for the priority judgment, bring into question a view that was widely held in the lending and insolvency community that, in order 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, the same scheme of priorities should apply in CCAA (and thus pre-filing security would rank in priority to a provincial deemed trust). So although DIP lenders’ priority charges were upheld, an uncertainty was created in respect of general CCAA proceedings and pre-filing security.

4. No Constructive Trust Imposed

The majority of the Court determined that although Indalex had breached its fiduciary duty as plan administrator, a constructive trust regarding the plan deficiency was not an appropriate remedy in this case. For financers, who generally require a level of predictability of outcome on matters such as priority, the application of a constructive trust had been a particularly troubling issue arising from the Court of Appeal decision.

Some Practical Implications and Our Initial Predictions

Following the somewhat unexpected findings of the Ontario Court of Appeal in April 2011, lenders to businesses with defined benefit pension plans in Ontario often took additional protective measures. These measures included greater due diligence regarding 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 comments noted in item 3, 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 at the outset (which would be stayed pending the CCAA proceeding) or 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 considered 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 is still effective in permitting a secured creditor to pursue a motion to lift a CCAA stay and petition a debtor into bankruptcy to reverse priorities.

With the removal of the equitable remedies aspect of the case, our initial view was that we believed asset-based lenders (ABL lenders) would feel much more comfortable financing companies with provincially registered (as opposed to federally registered) defined benefit plans that have a solvency deficiency and would not automatically reserve from availability the aggregate of all such solvency deficiencies. Instead, we expected that ABL lenders would consider whatever uncertainties remained on a case-by-case basis, including the credit profile of the borrower, the quantum of assets exposed, whether there are multiple plans and whether any steps to wind up any locations/plans have been commenced.

We also expected ABL lenders to require (or have early trigger to) full cash dominion, which would 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.

Further, we expected that lenders would continue to include enhanced representations, warranties and covenants (including default triggers and prohibitions on wind-ups and creating new defined benefit plans) wherever possible, as they had been doing prior to the Supreme Court decision. We also thought that lenders might be more likely to take federal Bank Act4. security in the future, if able to do so under the terms of this federal statute.

Loans Committed and Amended After the SCC Decision

From what we have seen in the market in the first couple of months following the SCC decision in Indalex, it appears that our initial expectations have been more or less accurate to date. We are aware of a number of significant market developments, including the following:

Forestry (Canada):

• elimination of reserve of all defined plan deficiencies (which prior to the SCC decision had effectively frozen all liquidity).

Forestry (Canada and United States):

• reasonable discretion of an ABL lender to establish reserves in good faith to reflect the status of all ongoing developments with respect to Ontario pension plans against Ontario inventory (and AR if chief executive office in Ontario), but only for unfunded defined benefit liabilities in Ontario PBA plans, with no closing reserve;
• enhanced reporting and triggers;
• no new defined benefit plans; and
• prohibition of termination in whole or in part of any Ontario PBA plan.

Manufacturing (Canada and United States)

• reserve for some monthly contributions, but no reserve for wind-up deficiency prior to detailed trigger events;
• restrictions on new defined benefit plans and on acquisitions that included new defined benefit plans; and
• enhanced reporting requirements and modified default triggers.

As always, the devil is in the details and each transaction needs to be approached on a case-by-case basis. Lenders seem to be taking that approach. We are seeing nuanced requirements and restrictions depending upon the type of borrower and, in some cases, the specific lenders involved. We are also seeing different approaches in terms of the flexibility required by lenders to apply reserves in the future.

Endnotes:

1. Sun Indalex Finance, LLC v. United Steelworkers, [2013] S.C.J. No. 6 (S.C.C.).
2. R.S.C. 1985, c. C-36 [CCAA].
3. R.S.O. 1990, c. P.8 [PBA].
4. S.C. 1991, c. 46.