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13 February 2013
The Supreme Court of Canada recently released its much-anticipated decision in the Indalex Limited proceedings under the Companies' Creditors Arrangement Act. The decision is important for secured lenders, both in the context of an insolvency proceeding (ie, debtor-in-possession (DIP) lenders) and outside such proceedings (ie, secured lenders). The court scrutinised whether defined benefit pension plan wind-up deficiencies are subject to the deemed trust provided for by the Pension Benefits Act (Ontario) and the priority of the deemed trust in respect of a charge granted in favour of the DIP lenders that funded Indalex's proceedings under the Companies' Creditors Arrangement Act.
In a four-to-three decision (with three separate written judgments), the Supreme Court held that an employer's obligations for funding deficiencies that arise on the winding-up of a defined benefit pension plan are included in the Pension Benefits Act deemed trust provisions and, as a result, enjoy priority over secured lenders. When providing financing to borrowers with defined benefit pension plans, secured lenders should consider carefully the appropriate provisions in their credit agreements that set out, among other things, strict reporting obligations and ongoing monitoring of the debtor's affairs.
DIP lenders can take comfort in the court's unanimous (seven-to-zero) decision that a court-ordered, super-priority charge securing advances to an insolvent debtor will have priority over the Pension Benefits Act deemed trust provisions.
In situations where a company acts as pension plan administrator (ie, an employer-administrator), it owes a fiduciary duty to the plan beneficiaries. The employer-administrator must take steps to avoid conflicts of interest that may arise as a result of the insolvency proceedings of the debtor employer and quickly deal with any conflicts that do arise. Although the judges did not agree as to the steps that the employer-administrator must take at various stages in order to avoid a conflict of interest, the court was unanimous in its assessment that any motions seeking approval of DIP financing, as well as a super-priority charge in favour of DIP lenders, must be on reasonable notice to pension plan beneficiaries. Furthermore, steps must be taken by the employer to ensure that pension plan members are represented properly at hearings that directly affect their interests, including motions regarding the terms of DIP financing.
As is common in Companies' Creditors Arrangement Act proceedings, Indalex secured DIP financing to enable it to continue operations during its restructuring process. The Ontario Superior Court of Justice (which has jurisdiction under the act) issued an order approving the DIP financing and, as security for the advances granted to the DIP lenders, a charge that enjoyed priority over all other creditors. At the time of filing the proceedings, Indalex was an administrator of two registered defined benefit pension plans - one for salaried employees and another for executives. Both plans faced funding deficiencies. At the time of commencement of the proceedings, the salaried plan was being wound up, but the executive plan was not.
As part of the proceedings, Indalex sold its business operations as a going concern to SAPA Holding AB. At closing, Indalex owed US$27 million to the DIP lenders. A portion of the sale proceeds was paid to the DIP lenders and US$6.75 million was retained in reserve, pending a determination of the pension plan members' rights. The payment of the sale proceeds to the DIP lenders left a US$10 million shortfall, which was paid by Indalex's US parent pursuant to a guarantee.
The pension plan members brought a motion for a declaration that a deemed trust equal in amount to the unfunded pension liability was enforceable against the sale proceeds held in reserve and had priority over the DIP lenders and the US parent guarantor. The deemed trust provisions set out in the Pension Benefits Act provide that certain amounts payable by an employer in respect of its pension plan obligations are deemed to be held in trust for the plan beneficiaries, and therefore enjoy priority over the employer's other creditors.
The Ontario Superior Court of Justice dismissed the plan members' motion at first instance. On appeal, to the surprise of insolvency practitioners across the country, the Ontario Court of Appeal sided with the pension plan members and held that they were entitled to payment out of the sale proceeds in priority to the DIP lenders (for further details please see "Debtor-in-possession lending charge: when a super-priority charge is not so super").
Deemed trust and pension wind-up deficiency
An employer's liability on the winding-up of a pension plan has two components. First, it must pay an amount equal to the total of all payments that are due or have accrued, and that have not been paid into the pension fund (ie, the current service costs). Second, the employer must pay all additional sums to the extent that the assets of the pension fund are insufficient to cover the value of all immediately vested and accelerated benefits and grow-in benefits. This latter liability is known as the 'wind-up deficiency'.
Four of the Supreme Court judges, comprising the majority on this issue, held that amounts payable in respect of any wind-up deficiency are included in the deemed trust provisions of the Pension Benefits Act. The issue was strictly one of statutory interpretation and came down to whether the wind-up deficiency could be considered "accrued to the date of wind-up". Utilising grammar, statutory interpretation principles and legislative intent as their guide, the court's two main judgments differed in their findings in this regard with the majority holding that the wind-up deficiency was properly considered accrued before the date of the winding-up.
Before the Indalex Ontario Court of Appeal decision, it had been generally understood that the Pension Benefits Act deemed trust provisions extended only to current service costs and not to any wind-up deficiency. The Supreme Court has now confirmed that any wind-up deficiency amounts payable by an employer are included in the statutory deemed trust and will have priority over secured lenders - at least outside of the context of DIP lending in an insolvency proceeding.
Priority of deemed trust
The Supreme Court held unanimously that the provincial deemed trust under the Pension Benefits Act did not have priority over the super-priority charge granted by the Ontario Superior Court of Justice to the DIP lenders. The Supreme Court noted that court-ordered priority based on the Companies' Creditors Arrangement Act has the same effect as statutory priority. Furthermore, where the Ontario Superior Court had granted priority to a DIP charge that conflicted with provincial priority schemes, under the doctrine of paramountcy, the court-ordered DIP charge superseded the provincial deemed trusts. Presumably this would apply equally to a DIP charge granted in respect of proposal proceedings commenced under the Bankruptcy and Insolvency Act (Canada).
Breach of fiduciary duty as employer-administrator
As is common practice for Ontario employers with defined-benefit pension plans, Indalex acted as each plan's administrator. In its capacity as employer-administrator, all parties agreed that Indalex owed a fiduciary duty to the plan members, which included avoiding conflicts of interest.
Companies' Creditors Arrangement Act proceedings
The Supreme Court considered the actions taken by Indalex in contemplation of the proceedings, with regard to whether such actions constituted a breach of Indalex's fiduciary duty as employer-administrator. The court also set out the steps that an employer-administrator should take to avoid such conflicts.
A majority of the Supreme Court held that filing for protection under the Companies' Creditors Arrangement Act gave rise to no conflict of interest or duty on the part of Indalex. However, the court unanimously held that Indalex had a duty to provide plan members with reasonable notice of the motion seeking approval of the DIP financing, and the granting of a super-priority charge in favour of the DIP lenders. Indalex breached this duty by:
When an employer-administrator finds itself in a conflict, Justice Cromwell held that it must bring the conflict to the attention of the Companies' Creditors Arrangement Act judge, who may consider it appropriate to appoint an independent administrator or representative counsel. In effect, the Supreme Court unanimously rejected the theory put forward by the appellants that the employer-administrator could continue to act as both the restructuring debtor and employer-administrator in such circumstances by "wearing two hats".
At the same time that Indalex sought approval of the sale to SAPA, it applied to the Ontario Superior Court of Justice to lift the stay of proceedings in order to file an assignment into bankruptcy. Three of the Supreme Court judges held that this was not a breach of Indalex's fiduciary duty; two judges held that it was done with an intent to harm the interests of the pension plan members (and was therefore a breach); and the remaining two made no comment on this issue.
Constructive trust remedy
The Ontario Court of Appeal found that Indalex had breached its fiduciary duty owed to the plan beneficiaries and, in order to rectify the breach, imposed a constructive trust over the sale proceeds held in reserve in favour of the beneficiaries. The majority of the Supreme Court (five-to-two) held that the imposition of the constructive trust over the sale proceeds was inappropriate, as the sale proceeds did not arise as a result of Indalex's breach of fiduciary duty. Justice Deschamps held that courts should not use equity to do what they wish that Parliament had done through legislation.
Doctrine of equitable subordination
Out of the three judges who provided written reasons, Deschamps was the only one that considered the application of the doctrine of equitable subordination. US bankruptcy courts employ this doctrine to subordinate claims of prior-ranking creditors in favour of subordinate claimants in circumstances where the prior-ranking claimants acting inequitably in respect of the subordinate creditors. Deschamps noted that the Supreme Court had previously left for future determination the operation of equitable subordination in Canada, but declined to endorse it in the Indalex decision. She held there was no evidence that the DIP lenders had committed a wrong or engaged in inequitable conduct. As a result, whether the doctrine of equitable subordination can be invoked in Canada remains an open issue.
In circumstances where an employer seeks to wind up a defined benefit pension plan, amounts payable by the employer in respect of any wind-up deficiency amount are included in the Pension Benefits Act deemed trust provisions and will have priority over secured lenders. Court-ordered, super-priority charges securing DIP financing will have priority over the Pension Benefits Act deemed trust provisions. Where an employer-administrator has commenced proceedings under the Companies' Creditors Arrangement Act, any motions seeking approval of DIP financing and a super-priority charge in favour of DIP lenders must be on reasonable notice to pension plan beneficiaries.
Although three of the Supreme Court judges held that an employer-administrator's decision to bring a motion seeking authorisation to file an assignment in bankruptcy did not amount to a breach of its fiduciary duty, without a majority decision on this issue, the question as to whether such action constitutes a breach remains an open issue. It is also unclear whether the doctrine of equitable subordination could be invoked in different circumstances to subordinate the claims of prior-ranking secured creditors in favour of junior-ranking creditors.
The Supreme Court provided no guidance as to the steps that a secured lender should take to protect its interests in the event of a winding-up of a borrower's defined benefit pension plan. It may therefore be prudent for secured lenders to evaluate the terms of credit agreements entered into with borrowers that maintain defined benefit pension plans to ensure that their interests are protected in the event that the borrower encounters financial difficulties.
For further information on this topic please contact John Salmas, Kenneth David Kraft or Sara-Ann Van Allen at Heenan Blaikie LLP by telephone (+1 416 360 6336), fax (+1 416 360 8425) or email (firstname.lastname@example.org, email@example.com or firstname.lastname@example.org).
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Kenneth David Kraft