National Insolvency ReviewOctober 2010 Volume 27, No.5
General Editor: Justin R. Fogarty, B.A., LL.B., LL.M
VOLUME 27, NUMBER 5Cited as (2010), Nat. Insol. ReviewOCTOBER 2010
• COURT DECLINES TO APPROVE SALE OF ASSETS
AS PART OF PROPOSAL PROCEEDINGS•
• In This Issue •
COURT DECLINES TO APPROVE SALE OF ASSETS AS PART OF PROPOSAL PROCEEDINGS
Roger Jaipargas........... 49
CASE COMMENT — DURA AUTOMOTIVE SYSTEMS (CANADA) LTD. (RE)
Michael Casey...... ...... 51
LIMITATIONS IN USE OF PURCHASE-MONEY SECURITY INTEREST IN
CROSS-COLLATERALIZATION
Sandra Appel...... ...... 52
CANWEST GLOBAL CASE
FURTHER CONSIDERS NEW CCAA
David Ward...... ...... 54
THE BEST DEFENCE IS ... A GOOD DEFENCE
Lisa Brost and Myriam Seers...... ...... 55
CASE COMMENT —
CAPITAL ONE v. SOLEHDIN
Alex Tarantino...... ...... 57
ENFORCEABILITY OPINIONS —
THE ONGOING NEED FOR INDEMNITIES
Jennifer E. Babe and Andre P. Kuyntjes......... 58
Roger Jaipargas
Borden Ladner Gervais LLP
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National Insolvency ReviewOctober 2010 Volume 27, No.5
In the recent decision of Justice Cumming Hypnotic Clubs Inc. (Re) (“Hypnotic” or the “Debtor”), [2010] O.J. No. 2176, the court dismissed a motion by the Debtor for a sale of its assets pursuant to s. 65.13 of the Bankruptcy and Insolvency Act [BIA], R.S.C. 1985, c. B-3.
The Debtor, which operated a night club management company filed a Notice of Intention to Make a Proposal (“NOI”) on February 17, 2010 under s. 50.4 of the BIA. A. Farber & Partners Inc. was named as proposal trustee (“Farber” or the “Proposal Trustee”).
The Debtor was a tenant under a sublease from Muzik Club’s Inc. (“Muzik”). Muzik was a related person to Hypnotic. On May 5, 2010 Hypnotic entered into an Asset Purchase Agreement (the “APA”) to sell its assets to Muzik, in trust for its nominee, subject to court approval. The result would be that the intended sale of the Hypnotic assets would be to a new corporation which would be related to Muzik.
The Proposal Trustee indicated that the process leading to the proposed sale to Muzik (in trust for its nominee) was reasonable in the circumstances because the sublease had expired and Hypnotic was now on a month-to-month tenancy. Further, under the terms of the sub-tenancy arrangement Muzik had the unfettered discretion as to who was acceptable as a new tenant. Muzik also stated that it would not entertain offers to lease the premises from an unrelated party. Under the terms of the APA, the proposed purchase price was $450,000. The Proposal
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EDITORIAL BOARD
GENERAL EDITOR
Justin R. Fogarty, B.A., LL.B., LL.M.
Davisllp, Toronto
EDITORIAL BOARD MEMBERS
Gerald N. Apostolatos, Langlois Kronström Desjardins S.E.N.C.R.L./LLP, Montréal Patrick Shea, Gowling Lafleur Henderson LLP, Toronto Christopher W. Besant, Cassels Brock & Blackwell LLP, Toronto Joseph Marin, Miller Thomson LLP, Toronto Huber Sibre, BCF LLP, MontréalSteven Graff, Aird Berlis LLP,
TorontoDavid R.M. Jackson, Taylor McCaffrey LLP, WinnipegChris D. Simard, Bennett Jones LLP, CalgaryRobert P.W. Sloman, Farris Vaughan, Wills & Murphy, VancouverJohn R. Sandrelli, Fraser Milner Casgrain LLP, Vancouver.
Note: This newsletter solicits manuscripts for consideration by the General Editor, who reserves the right to reject any manuscript or to publish it in revised form. The articles included in National Insolvency Review reflect the views of the individual authors. This newsletteris not intended to provide legal or other professional advice and readers should not act on the information contained in this report without seeking specific independent advice on the particular matters with which they are concerned.
Trustee’s Third Report noted that two independent appraisals estimated the assets (equipment and inventory) of Hypnotic to have a gross liquidation value of less than $282,000. The only secured creditor of Hypnotic, Generation of Dance Inc., was related to Muzik and was owed approximately $325,000. A legal opinion had been obtained that provided that the security was valid and enforceable. The largest arm’s length unsecured creditor of Hypnotic was Penny Telios who held a judgment against Hypnotic for $740,879.78 for monies loaned to Hypnotic. The effect of this judgment was to give Ms. Telios a veto over any proposal that Hypnotic made to its creditors. In light of the position taken by Muzik that it would not agree to any subtenant who is not a related party to Muzik, this meant that Muzik practically became the only potential purchaser of Hypnotic’s assets and there had not been any sales process undertaken by Hypnotic to offer the assets for sale to the public.
In connection with a motion brought by a Debtor in proposal proceedings for approval of a sale of its assets, the court must consider ss. 65.13(4) and (5) of the BIA which provide:
65.13(4) Factors to be considered — In deciding whether to grant the authorization, the court is to consider, among other things,
(a) Whether the process leading to
the proposed sale or disposition was reasonable in the circumstances;
(b) Whether the trustee approved the process leading to the proposed sale or disposition;
(c) Whether the trustee filed with the court
a report stating that in their opinion the sale
or disposition would be more beneficial to
the creditors than a sale or disposition under
a bankruptcy;
(d) The extent to which the creditors
were consulted;
(e) The effects of the proposed sale or disposition on the creditors and other interested parties; and
(f) Whether the consideration to be received for the assets is reasonable and fair, taking into
account their market value.
(5) Additional factors — related persons — If the proposed sale or disposition is to a person who is related to the insolvent person, the court may, after considering the factors referred to in subsection (4), grant the authorization only if it is satisfied that
(a) Good faith efforts were made to sell or
otherwise dispose of the assets to persons who are not related to the insolvent person; and
(b) The consideration to be received is superior to the consideration that would be received
under any other offer made in accordance
with the process leading to the proposed sale or disposition.
Due to the position taken by Muzik that it would only rent the premises to a related party and no one else can enter the premises to run the business at the current location, there was effectively no market for any third party to purchase the assets and operate from the current location. The court noted that the Proposal Trustee approved the process leading to the proposed sale. The court found that the Proposal Trustee concluded that the consideration to be received for the sale of the assets was fair and reasonable, taking into account the market value as established by the two appraisals obtained. Further, the Proposal Trustee was of the view that the APA provided for a better recovery to the secured creditor and the arm’s length creditors than would be achieved through a bankruptcy. Accordingly, the court concluded that the factors to be considered as required by s. 65.13(4) of the BIA were taken
into account.
The court then turned its attention to the additional factors to be considered where a proposed sale or disposition is to a person who is related to the insolvent person, as required by s. 65.13(5) of the BIA. In considering this provision of the BIA the court concluded as follows:
Given the impossibility of any real market for a sale of Hypnotic’s assets to other than Muzik, a related person, and given the appraisals as to the liquidation value of those assets, the reasonable conclusion is that the consideration to be received by the Revised APA is superior to the consideration that would be received under any other conceivable offer.
This brings me to the factor required to be met by
s. 65.13(5)(a). Giving consideration to the entirety of the evidentiary record and the intent and policy underlying the BIA, I am not satisfied that good faith efforts have been made to sell or otherwise dispose of Hypnotic’s assets to unrelated parties of Hypnotic within the intent and meaning of this provision.
The intent and policy underlying the BIA is that creditors should consider and vote upon a proposal advanced pursuant to an NOI as they see fit in their own self interest. That objective is defeated in the instant situation if the revised APA is approved.
Justice Cumming was particularly concerned with the fact that if the court approved the proposed sale, Muzik would end up benefiting given its position of effectively controlling who the sub-tenant would be, and through the position adopted by Muzik, there would be no real market for the Hypnotic business. By taking this position, the court was concerned that Muzik effectively removed itself from having to bid a competitive price for the business of Hypnotic. This led Cumming J. to conclude as follows:
Given the circumstances, and taking into account the underlying policy of the BIA of letting creditors vote if they choose in respect of accepting or rejecting a proposal, in my view, the factor of a required good faith effort stipulated by s. 65.13(5)(a) has not been met.
The court therefore declined to approve the sale of the Hypnotic assets and dismissed the motion.
[Editor’s note: Roger Jaipargas is a partner in the Insolvency and Restructuring Group of Borden Ladner Gervais LLP. He practises exclusively in the areas of commercial insolvency, restructuring and secured transactions. He routinely appears before the Ontario Superior Court of Justice (Commercial List).]
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National Insolvency ReviewOctober 2010 Volume 27, No.5
• CASE COMMENT — dURA aUTOMOTIVE sYSTEMS (cANADA) lTD. (rE) •
Michael Casey
Cassels Brock & Blackwell LLP
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National Insolvency ReviewOctober 2010 Volume 27, No.5
Typically under the Companies’ Creditors
Arrangement Act [CCAA], R.S.C. 1985, c. C-36, when a debtor brings an application to extend the stay period, the court will grant the extension, so long as the applicant debtor is acting in good faith and with due diligence. In the vast majority of such extension applications the debtor has the support of the court-appointed Monitor. The recent Ontario Superior Court of Justice case Dura Automotive Systems (Canada) Ltd. (Re), [2010] O.J. No. 654, is notable as it is a rare example where a CCAA debtor’s application for an extension of the stay was not supported by the Monitor and was denied by the Court.
On February 11, 2010 Dura Automotive Systems (Canada) Ltd. (the “Debtor”) sought an order for an extension of the stay of proceedings under the CCAA. Surprisingly, the Monitor did not support the application to extend the stay as it did not believe the Debtor was acting in “good faith and with due diligence.” The Monitor did not support the application in part because a key stakeholder who had the ability to block a plan had made it clear it was unacceptable to them. Accordingly, the Monitor contended that continuing the CCAA proceedings would result in further dissipation of the remaining cash in the Debtor’s estate, without any reasonable assurance that the continuation would result in a viable plan.
After assessing the circumstances, Justice Morawetz determined that he was not satisfied that the Debtor had met the test required to obtain an extension of the stay period. In making his ruling, Morawetz J. emphasized that the fundamental issue in the proceedings was the pension plan deficit of approximately $9 million. He felt that in negotiating with the pension plan administrator and unions, the Debtor had changed it tactics at the “11th hour” to present the plan to the retirees, when the Debtor realized that negotiations with the original group were not going to be successful. Justice Morawetz felt that the last minute change in tactics, lead to the inescapable conclusion that the Debtor had not acted in good faith in negotiating with the original group of stakeholders. Justice Morawetz determined that the Debtor gave every appearance that, up to the last minute, it was negotiating with the appropriate representative groups and shifted strategy when it was clear that an agreement was unlikely. He concluded that
by questioning the representative status of the parties at the last possible moment, the Applicant [Debtor] has demonstrated that it cannot be said to be acting in good faith and with due diligence.
This recent decision highlights, that although rare, the court will in the appropriate situation deny an application by a CCAA debtor for an extension of the stay period. The determinative factors considered by the Court in denying the stay extension were that the negotiations were unlikely to result in a viable plan, and that the Debtor was not acting in good faith and with due diligence. Unquestionably, the fact that the Debtor’s application was not supported by the Monitor was a significant contributing factor in the Court’s denial of the extension of the stay.
[Editor’s Note: Michael Casey is an associate in the Financial Services and the Insolvency & Restructuring Groups at Cassels Brock. Mr. Casey has been involved in financing and insolvency transactions, as well as a number of large advocacy files.]
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National Insolvency ReviewOctober 2010 Volume 27, No.5
• LIMITATIONS IN USE OF PURCHASE-MONEY SECURITY INTEREST
IN CROSS-COLLATERALIZATION •
Sandra Appel
Davis LLP
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National Insolvency ReviewOctober 2010 Volume 27, No.5
A recent decision of the Alberta Queen’s Bench[1] has raised some questions about PMSI proceeds and cross-collateralization of assets secured by these types of security interests. It has been suggested that this decision is unique and establishes that using a purchase-money security interest (“PMSI”) as collateral for other indebtedness of the debtor is dangerous. But is this decision really so radical?
Facts
The Receiver of Ramco Sales Inc. (“Ramco”), an equipment supplier, sought a declaration that it was entitled to the equity remaining after it sold four pieces of equipment in which Canadian Western Bank (“CWB”) had a PMSI. The four pieces of equipment had been purchased by the insolvent Ramco with monies provided by CWB pursuant to a loan agreement and security. The security interest was in items specified in Schedule “A” and in subsequent schedules. Attached to the master agreement were 13 schedules. The equipment at issue was in Schedules 1, 6, 7 and 8 and the schedules spanned about 15 months. CWB was also owed monies with respect to other equipment. Royal Bank of Canada (“Royal Bank”) had a prior registered general security agreement (“GSA”).
Issue
The major issue addressed by the Court was who was entitled to the remaining equity in the four items of equipment after each item had been sold. CWB argued that any surplus after each piece of equipment had been disposed of should be used to pay off any remaining indebtedness on the other three, with the balance directed to its general loan. Royal Bank and the Receiver argued that each piece of equipment was discreet. If there was any surplus after the sale of that item, the surplus should go to the Receiver.
Decision
The Court considered s. 61 of the AlbertaPersonal Property Security Act [the PPSA], RSA 2000, c. P-7, (similar to s. 64 of the OntarioPersonal Property Security Act, R.S.O. 1990, c. P.10). It looked at each item of equipment as collateral for the loan and determined that s. 61 provides that if there is any surplus after the collateral has been disposed of, it goes first to the party with a subordinate security interest to the PMSI. In this case, it was Royal Bank with its prior registered GSA.
The Court went on to consider why a PMSI takes priority over a prior secured creditor who has an “after-acquired property clause” and commented upon a major characteristic of a PMSI; that it be limited to loans made that can be traced to identifiable discreet items of property.
The overall intent of the PPSA is to provide an ordered regime to facilitate commerce in a balanced way for a debtor and its creditors ... to permit a PMSI creditor to use surplus funds from an identifiable existing asset to pay off debt with respect to other identifiable existing assets or any deficiency with respect to assets no longer available would upset the balance … [and] the PMSI creditor would usurp the priority of the prior secured creditor.
Discussion
In the circumstances the decision is reasonable. Although the decision itself does not set out a great many facts, we know that each of the four pieces of equipment was described in a separate schedule and we can extrapolate therefore that each had a separate payment schedule. Each piece of equipment was sold separately. So the Receiver could determine the amount of the deficiency after the sale of each item of equipment. Compare this with a security agreement wherein four items of equipment are described in one schedule, with a blended payment and the same right to apply payments to the indebtedness in such manner as the secured party determines in its discretion, as CWB could in respect of Ramco. On the sale of these four items of equipment, either individually or as a package, the surplus would still rightly go to the prior secured creditor with a general security agreement. This is the concept afforded to a PMSI by the statute.