April 3, 2012

A Decent Proposal: Hot Button Issues under Part III of the BIA

A recent decision of the Ontario Superior Court of Justice (Commercial List), Re Kitchener Frame Limited,1 considered three hot-button issues in a proposal proceeding under Part III of the Bankruptcy and Insolvency Act (the “BIA”).2 In his reasons, Morawetz J. considered substantive consolidation, third party releases and the interaction between the BIA and the Companies’ Creditors Arrangement Act (“CCAA”).3

These reasons of Morawetz J. were written in connection with an unopposed motion requesting: (1) the sanction of a consolidated BIA proposal in respect of two related inactive companies; and (2) the authorization of the Proposal Trustee to take all steps necessary to implement the proposal. The two Applicants – Kitchener Frame Limited and Thyssenkrupp Budd Canada Inc. – were non-operating entities with mounting pension and other post employment benefits (“OPEB”) obligations to their former employees. Upon the cessation of the companies’ operations, such obligations were funded by a parent company. However, that arrangement was unsustainable given that the companies were not operational.

The Applicants commenced BIA proceedings on July 4, 2011. On July 7, 2011, the Court granted the Applicants: (1) procedural consolidation orders permitting the Applicants to file a single consolidated proposal; (2) orders appointing separate representative counsel for each of the union and non-union OPEB creditors and authorizing continued payments in respect of OPEB claims during the proceedings; and (3) a claims procedure order to identify and quantify the claims against the Applicants. On August 2, 2011, the Applicants received an extension of time to file a proposal to August 19, 2011.

Following negotiations, the parties reached an agreement for the proposal in principle, which included the following: (a) the OPEB claims would be compromised by a one-time lump-sum payment to the OPEB creditors; (b) the Applicants and their affiliates would forego any recoveries on their intercompany claims; and (c) it was a condition precedent of the agreement that the Applicants pay sufficient funds to the pension fund trustee to allow it to fully annuitize the Applicants’ pension obligations to satisfy those obligations in full. The consolidated proposal was filed on August 19, 2011, with certain amendments made on August 31, 2011. On September 1, 2011, the creditors’ meeting was held where the proposal was accepted by 99.9% in number and 99.8% in dollar value of the affected creditors. Canada Revenue Agency abstained from voting.

The proposal sanction hearing took place on September 16, 2011. In deciding whether to sanction the consolidated proposal, Morawetz J. considered the three-part test under s. 59(2) of the BIA. In order to satisfy the s. 59(2) test, the proposal must be: (a) reasonable; (b) calculated to benefit the general body of creditors; and (c) made in good faith. In his reasons for approving the proposal under s. 59(2), Morawetz J. explored three issues that clarify the law under the BIA.

Substantive Consolidation

Morawetz J. noted that although not expressly contemplated under the BIA, the Court may look to its incidental, ancillary and auxiliary jurisdiction under BIA s. 183 and its equitable jurisdiction to grant an order for substantive consolidation of the Applicants’ proposal proceedings. However, substantive consolidation should not be granted at the expense of, or possible prejudice of, any particular creditor. Morawetz J. took into account the intertwined nature of the Applicants’ assets and liabilities and the lack of prejudice to creditors in either estate in allowing the substantive consolidation of the Applicants’ estates.4

Third Party Releases

The proposal contained broad releases in favour of the Applicants, a number of third parties and any person liable jointly or derivatively through any or all of the beneficiaries. The release covered all affected claims, pension claims and claims relating to a certain escrow fund. Such claims were released and waived to the full extent permitted by applicable law, with the exception of any criminal or other wilful misconduct or certain claims against the Applicants’ former directors under s. 50(14) of the BIA. In approving the releases, Morawetz J. held that the beneficiaries of the releases contributed in a tangible and realistic way to the proposal. Without the releases, it was unlikely that certain of the released parties would have been prepared to support the proposal. The alternative of a bankruptcy of the Applicants would have lead to significantly eroded recoveries for their unsecured creditors.5

Further, Morawetz J. paid particular attention to the fact that the BIA doesn’t prohibit third party releases and that the release satisfied the criteria established under the CCAA decision in Metcalfe & Mansfield Alternative Investments II Corp. (Ltd.).6 He also considered the lack of objection to the release by any creditors or stakeholders who received information about the release in advance of the creditors’ meeting from the Proposal Trustee. A proposal under the BIA is akin to a contract and parties are entitled to put anything into a proposal that could lawfully be incorporated into any contract where the prescribed majority of creditors agrees, keeping within the express limitations of the BIA.7

Subsection 62(3) of the BIA provides that “[t]he acceptance of a proposal by a creditor does not release any person who would not be released under this Act by the discharge of the debtor.” Some Courts have interpreted this subsection to be prohibitive of third party releases, but Morawetz J. interpreted it as “protective rather than prohibitive.” In his view, s. 62(3) was clearly intended to fulfill a very limited role: to confirm that there is no automatic release of the specific types of co-obligors contemplated by the BIA (partners or co-trustees of the bankrupt, parties jointly bound by a contract with the bankrupt or sureties of the bankrupt – see BIA s. 179). Section 62(3) of the BIA does not go further to preclude the creditors and the court from approving a proposal that contains the third-party release of those types of co-obligors.9

Harmonious Interpretation of the BIA and CCAA

Morawetz J. re-emphasized that the Canadian insolvency statutes “should be interpreted in a manner that is flexible rather than technical or literal.” Though consistent with the judicial interpretation of insolvency statutes generally, Morawetz J. adds that this principle militates in favour of adopting an interpretation of the BIA that is harmonious, to the greatest extent possible, with the interpretation that has been given to the CCAA (see the approach of the Court in Re Ted Leroy Trucking).9 An interpretation of the BIA that leads to a result that is different from the CCAA should only be adopted pursuant to clear statutory language. Morawetz J. saw no principled basis on which the analysis and treatment of a third-party release in a BIA proposal proceeding should differ from a CCAA proceeding.10

1 Re Kitchener Frame Limited, 2012 ONSC 234 [KFL],

2 Bankruptcy and Insolvency Act, RSC 1985, c B-3 (the “BIA”).

3 Companies’ Creditors Arrangement Act, RSC 1985, c C-36 (“CCAA”).

4 KFL, supra at paras. 30-32.

5 KFL, supra at paras. 83-92.

6 Metcalfe & Mansfield Alternative Investments II Corp. (Ltd.), 2008 ONSC 587.

7 KFL, supra at para. 61.

8 KFL, supra at paras. 48-78.

9 Re Ted Leroy Trucking, 2010 SCC 60.

10 KFL, supra at paras. 46-83.