New Priorities? The Ontario Superior Court Applies Indalex and Reaches a Different Result
On February 2 and 9, 2012, the Ontario Superior Court released two decisions in the ongoing proceedings of Timminco Limited and Bécancour Silicon Inc. (together, the Timminco Entities) under the Companies’ Creditors Arrangement Act (CCAA) that further develop the law regarding pension claim priorities in insolvency proceedings. In these related decisions, Justice Morawetz issued orders creating charges to secure debtor-in-possession (DIP) financing, professional fees and other amounts, with super-priority over existing encumbrances, including any statutory deemed trusts imposed under the Ontario Pension Benefits Act (PBA) or the Québec Supplemental Pension Plans Act. The decisions are notable because, in his reasons, Justice Morawetz relied, in part, on the Ontario Court of Appeal’s reasons in Re Indalex Limited (Indalex) to support his decision to grant the super-priority. In Indalex, which in contrast to Timminco had an unfavourable outcome for the DIP lender, the Ontario Court of Appeal gave pension wind-up deficit claims priority over the court-ordered charge securing the DIP loan. (The Supreme Court of Canada will hear an appeal of the Indalex decision on June 5, 2012.)
The Timminco Entities sponsored one Ontario-registered and two Québec-registered defined benefit pension plans (Plans). All three Plans were underfunded by over $14 million on a solvency basis, and the Ontario-registered plan was, at the time of the Timminco Entities’ CCAA filing, in the process of being wound up.
The Superior Court’s first decision of February 2 involved the Timminco Entities’ request for an order granting three super-priority charges: (i) an "Administration Charge"; (ii) a "Directors’ and Officers’ Charge", and (iii) a charge to secure amounts to be paid under a key employee retention plan for employees deemed critical to a successful restructuring (collectively, the Administrative Charges). The Timminco Entities also sought an order suspending their obligations to make special payments to the Plans. The second decision of February 9 involved the Timminco Entities’ request for a super-priority charge to secure a DIP loan of over $4 million proposed to be advanced by QSI Partners Ltd. (DIP Charge).
The Communications, Energy and Paperworkers’ Union of Canada, supported by the United Steelworkers Union (Unions), opposed granting enhanced priority to the Administrative Charges and the DIP Charge over the pension claims (as well as any suspension of special payments) on the basis that, in the Unions’ view, there were insufficient facts showing that the super-priority or suspension in special payments to the Plans was necessary.
Regarding the Administrative Charges in particular, although the Unions conceded that the Court had the power to grant super-priority, they argued that such a grant is an extraordinary measure, which the Timminco Entities had failed to show was necessary in this case. Among other things, the Unions, relying on Indalex, argued that, under the doctrine of federal paramountcy, the Court would have to show that withholding super-priority from the Administrative Charges "would frustrate the company’s ability to restructure and avoid bankruptcy". In this case, the Unions argued that the Timminco Entities had not provided any restructuring plan, so granting super-priority to the Administrative Charges would be premature.
The Unions, again relying on Indalex, also argued that the Timminco Entities, as sponsor and administrator of the Plans, wear "two hats." While wearing the sponsor or company "hat", the directors of the Timminco Entities owe a fiduciary duty to the corporation, but while wearing the administrator "hat," they owe a fiduciary duty to the Plans’ beneficiaries. The Unions argued that, in seeking super-priority for the Administrative Charges and the DIP Charge, the Timminco Entities were in a conflict of interest and ignoring their obligations to the Plans.
Justice Morawetz rejected each of the Union’s arguments. In his February 2 decision, he relied on the Court of Appeal’s own statement in Indalex that "the CCAA judge can make an order granting a super-priority charge that has the effect of overriding provincial legislation, including the PBA."
Justice Morawetz also emphasized that the super-priorities requested in this case would not prejudice the Plans’ beneficiaries, because, in the absence of a super-priority, the likely outcome would be a bankruptcy in which they could achieve no better result. The judge expressly found that the Timminco Entities had not contravened the "two hats" principle emphasized in Indalex because it was in the simultaneous interests of both the companies’ and the Plans’ beneficiaries that the Timminco Entities avoid bankruptcy and continue restructuring. For this reason, he also ordered the suspension of special payments to the Plans.
In the February 9 decision, Justice Morawetz approved the requested super-priority for the DIP Charge over the objections of the Unions. He largely adopted his analysis from the February 2 decision granting super-priority to the Administrative Charges (and in fact attached those reasons to his February 9 decision as an appendix). In also rejecting the Unions’ argument that the DIP Charge should not be granted priority because it did not provide for funding of special payments, Justice Morawetz concluded that it was "unrealistic to expect that any commercially motivated party would make advances to the Timminco Entities for the purpose of making special payments or other payments under the pension plans."
McCarthy Tétrault Notes
The Timminco decisions are an important waypoint on the road to the Supreme Court of Canada’s appeal in Indalex. Although a number of practitioners have commented that the result in Indalex — giving pension wind-up deficits priority over a DIP loan — seems to have been motivated by the specific facts in that case, the Timminco decisions expressly consider and apply the analysis in Indalex to achieve a different outcome — priority for the DIP loan. Timminco may give employers and lenders renewed comfort that the court in a CCAA proceeding can and will grant priority for a DIP loan over any deemed trust for pension plan funding shortfalls in appropriate circumstances, and that the decision in Indalex is not an impediment to doing so.
Because the Timminco decisions only involved consideration of a DIP loan and charges created by court order at the outset of a case, Timminco does not address aspects of the Indalex decision that are of concern to lenders with security over working capital assets granted by security agreements governed by the Ontario Personal Property Security Act (PPSA). Under the PPSA, any deemed trust arising under the PBA has priority over security interests (other than purchase-money security interests) in inventory and accounts. In Indalex, it was decided that, upon the wind-up of a pension plan, the amount of the entire wind-up deficit is subject to the deemed trust. As a way to avoid the resulting situation in which an entire plan wind-up deficit could have priority over their security, secured lenders with accounts and inventory as their collateral sometimes seek to have a bankruptcy occur prior to any distribution of sale proceeds when a borrower’s assets have been sold in CCAA proceedings. In a bankruptcy, courts have held that the deemed trust loses its effectiveness and therefore its priority. This approach to "reverse priorities" has been accepted in the past by courts, but in the particular circumstances of Indalex, the Court of Appeal did not support the transition to a bankruptcy proceeding. As a result, there are many aspects of the Indalex decision in respect of which further direction and guidance from the Supreme Court of Canada could help to reduce uncertainty and facilitate commercial lending practices.
To view McCarthy Tétrault’s commentary to date on Indalex, please see our e-Alerts of April 8, 2011; April 21, 2011; and December 1, 2011, as well as Volume 5, Issue 1 of our Litigation Co-Counsel newsletter, available here.
For more information on how this case might specifically apply to you, please call any member of our Bankruptcy & Restructuring or Pensions, Benefits & Executive Compensation groups, or your regular McCarthy Tétrault lawyer.