In DIP Financing We Trust? Supreme Court of Canada to Hear Indalex Appeal
The Supreme Court has announced it will hear the appeal in the high profile Indalex Ltd., Re. The appeal is of great interest to the commercial litigation, insolvency and pension bar. Its outcome will be closely watched and may have dramatic impact on Canadian corporate reorganizations.
The Indalex decision arose out of the insolvency of Indalex Limited (“Indalex”) and its affiliated companies. Indalex was the Canadian subsidiary of an aluminum products manufacturer. It was a sponsor and administrator of two registered pension plans – one for salaried employees and another for executives. When Indalex obtained protection pursuant to the Companies’ Creditors Arrangement Act (“CCAA”), both of its pension plans were underfunded. Indalex obtained a court order enabling it to borrow funds pursuant to a debtor-in-possession (“DIP”) credit agreement. The court granted the DIP lender a super-priority charge on Indalex’s assets. Indalex’s U.S. parent guaranteed Indalex’s obligations to pay the DIP lender.
When Indalex was sold in the framework of CCAA proceedings, Indalex moved to approve the distribution of the sale proceeds to its DIP lender. The sale proceeds were not sufficient to repay the DIP lenders. The parent company covered the shortfall and claimed a portion of the proceeds, which was held in reserve by the monitor. The United Steelworkers labour union (“USW”) and a group of salaried executives objected to the distribution of the proceeds to the parent company, arguing that retirees and employees had a claim on the basis of a statutory deemed trust in respect of these funds.
At issue in the approval motion was the interpretation of section 57(4) of the Pension Benefits Act (Ontario) ("PBA”) which provides:
“Where a pension plan is wound up … an employer who is required to pay contributions to the pension fund shall be deemed to hold in trust for the beneficiaries of the pension plan an amount of money equal to employer contributions accrued to the date of the wind up but not yet due under the plan or regulations.”
In the first instance (Indalex Ltd., Re), Campbell J. approved the distribution. He held that no deemed trust was created in respect of the salaried executives’ plan because the wind up of their plan had not yet taken place at the time of the sale, and hence no deficiency existed. Campbell J. also dismissed the USW motion on the basis that since the Regulations permitted the company to make up the deficiency over a period of years, no deficiency existed until the company was required to pay such amounts.
A unanimous panel of the Ontario Court of Appeal disagreed. Gillese J. A., writing for the court, held that the liabilities of the employer accrued by the wind up date, rather than by the date when the payments were due. Therefore, the deemed trust prescribed by section 57(4) applied to all amounts owed by the employer on the wind up of the USW pension plan. Despite observing that on the plain wording of the statute no amounts were owed to the salaried executives’ plan, since it had not been wound up at the time of the sale, the court held that to so hold would permit Indalex to “rely on its own inaction” and “would be a triumph of form over substance.” As a result, the deemed trusts in favour of both pension plans ranked in priority to the DIP lender.
Furthermore, the Court of Appeal found that, in the circumstances of the case, Indalex was in breach of its fiduciary obligations to the funds and appears to have suggested that when a company approaches insolvency, it must transfer the administration of its pension fund to a third party:
“Indalex was not at liberty to resolve the conflict in its duties by simply ignoring its role as administrator. A fiduciary relationship does not end simply because it becomes impossible of performance. At the point where its duty to the corporation conflicted with its duties as administrator, it was incumbent on Indalex to take steps to address the conflict.”
The Court of Appeal appears to have been motivated, at least in part, by the specific factual situation arising out of the relationship between the insolvent Indalex and its parent company guarantor, which created an informational asymmetry vis-à-vis the pension plan members:
“[T]here were a number of different steps that Indalex could have taken to deal with these obligations. It chose not to. This is not a case in which the secured creditor is an arm’s length third party taken by surprise by the claims of the Plans’ beneficiaries. ... The equities are not equal. The Plans’ beneficiaries were vulnerable to the exercise of power by Indalex. They were not a part of the negotiations for the DIP financing nor were they involved in the sale negotiations. … Indalex, on the other hand, was fully aware of the Plans’ underfunding and the result to the pensioners of a failure to inject additional funds.”
The significance of this appeal is in its potential to alter the creditors’ priority in a corporate reorganization. Traditionally, it has been understood that DIP lenders rank ahead of pension plan members in an insolvency. The Indalex decision of the Ontario Court of Appeal held that, in some circumstances, pension funding obligations may rank ahead of DIP lenders, by virtue of the deemed trust prescribed by the PBA. Furthermore, the Supreme Court will be called upon to determine whether an employer can fulfil its fiduciary obligations to the plan members during a restructuring, or whether the duty to the members of the plan fundamentally conflicts with the duty of the corporation.
The Court of Appeal decision, if upheld, may have a negative effect on the availability of DIP financing in this province. At a minimum, DIP lenders will need to consider whether the debtor’s pension funds are underfunded and to what extent before extending financing. In turn, debtors will need to consider whether they can fulfil their obligations to the plan’s members and whether sufficient notice has been given to the plan members of the steps undertaken in the CCAA proceeding.
Notably, the decision will not affect “regular” secured lenders, whose priority ahead of statutory deemed trusts has been established by the Supreme Court in Royal Bank of Canada v. Sparrow Electric Corporation.
Sun Indalex Finance, LLC et al. v. United Steelworkers et al. (Ont.) (Civil) (By Leave)
Supreme Court Docket Number: 34308
No hearing date has been scheduled yet.
Companies' Creditors Arrangement Act debtor-in-possession credit arrangement Pension Benefits Act pension plan wind up registered pension plan administrator Supreme Court of Canada