May 31, 2012

A Partial “Roll up” DIP is Recognized in a Foreign Main Proceeding

In a recent decision, Re Hartford Computer Hardware Inc.,1 the Ontario Superior Court of Justice (Commercial List) (the “Court”) granted a recognition order pursuant to section 49 of the Companies’ Creditors Arrangement Act (the “CCAA”)2 which, among other things, approved a Final DIP Facility containing a partial “roll up” provision.  In granting this order, Morawetz J. reviewed the public policy exception outlined in section 61(2) of the CCAA and determined that the exception ought to be interpreted in a restrictive manner.  Further, Morawetz J. found that the “roll up” provision did not raise any public policy issues.

By way of background, on December 12, 2011, Hartford Computer Hardware Inc. (“Hartford”) and certain related entities (the “Chapter 11 Entities”) commenced Chapter 11 Proceedings (the “U.S. Proceedings”) in the Northern District of Illinois Eastern Division (the “U.S. Court”).  The following day, Morawetz J. granted certain interim relief in Canada including a stay of proceedings.  On December 15, 2011, the U.S. Court made an order authorizing Hartford to act as the Foreign Representative of the Chapter 11 Entities.  Subsequently, on December 21, 2012, Morawetz J. made two orders, an initial recognition order and a supplemental order that, among other things:

a) declared the U.S. Proceedings were a foreign main proceeding pursuant to Part IV of the CCAA;
b) recognized Hartford as the Foreign Representative of the Chapter 11 Entities;
c) appointed FTI Consulting Inc. as the court-appointed Information Officer in the proceedings;
d) granted a stay of proceedings; and
e) recognized and made effective in Canada certain first day orders granted by the U. S. Court including an Interim Utilities Order and an Interim DIP Facility Order.3

On February 1, 2012, Hartford sought the recognition of the following three orders granted by the U.S. Court in the U.S. Proceedings: (a) the Final Utilities Order; (b) the Bidding Procedures Order; and (c) the Final DIP Facility Order.

As was noted by Morawetz J., the first two orders were relatively routine in nature and it was therefore appropriate to recognize and give effect to those orders.  In contrast, the Final DIP Facility Order warranted further consideration.  The Final DIP Facility contained a partial “roll up” provision whereby all cash collateral in possession or control of the Chapter 11 Entities on the petition date or coming into possession after the petition date (the “Cash Collateral”) was deemed to have been remitted to the pre-petition secured lender for application to and repayment of the pre-petition revolving debt facility with a corresponding borrowing under the DIP facility.4  This provision would likely be prohibited in a CCAA proceeding (as opposed to a foreign main proceeding) pursuant to section 11.2 of the CCAA, which provides that an interim financing charge in favour of a DIP lender may not secure an obligation that exists before the initial order is made.

Morawetz J. reviewed the Information Officer’s report, which reported that: (1) the U.S. Court found that good cause had been shown for entry of the Final DIP Facility Order, as the Chapter 11 Entities’ ability to continue to use the Cash Collateral was necessary to avoid immediate and irreparable harm to the Chapter 11 Entities and their estates; (2) the granting of the Final DIP Facility Order was supported by the Unsecured Creditors’ Committee in the U.S. Proceedings; (3) the Canadian unsecured creditors would be treated no less favourably than the U.S. unsecured creditors; and (4) there would be no material prejudice to the Canadian creditors if the Final DIP Facility Order was recognized; and (5) the Information Officer concluded that the recognition was appropriate in the circumstances.5

Morawetz J. also reviewed section 49 of the CCAA which provides that, in recognizing an order of a foreign court, the court may make any order that it considers appropriate, provided the court is satisfied that it is necessary for the protection of the debtor company’s property or the interests of the creditor or creditors.6  Morawetz J. commented that it was necessary to emphasize that the motion was for a recognition order in a foreign main proceeding and found it was a significant factor that the U.S. Court had already granted the order after a hearing before the U.S. Court.7  Further, Morawetz J. found it important to note that the Chapter 11 Entities had already borrowed $1 million under the Interim DIP Facility.  In addition, the Cash Collateral on hand as of the petition date was effectively spent in the Chapter 11 Entities' operations and replaced with advances under the Interim DIP Facility in December 2011 such that all cash in the Chapter 11 Entities' accounts as of the date of the Final DIP Facility Order were proceeds from the Interim DIP Facility.8

Based on the forgoing, Morawetz J. found the recognition of the Final DIP Facility Order was necessary for the protection of the debtor company’s property and for the interests of the creditors.9  In reaching this conclusion, Morawetz J. took into account the public policy exception set out in section 61(2) of the CCAA which states: “Nothing in this Part prevents the Court from refusing to do something that would be contrary to public policy.”10  Morawetz J. found that this exception should be interpreted in a restrictive manner, consistent with the Guide to Enactment of the UNCITRAL Model Law on Cross-Border Insolvency.11  Morawetz J. concluded that the partial “roll up” contained in the Final DIP Facility Order did not raise any public policy issues.

This case may provide some interesting insight with respect to trends in cross-border proceedings going forward.  In this case, by having an ancillary proceeding in Canada with a foreign main proceeding in the U.S. Court, the Canadian Court was able to recognize a DIP order that would likely not be granted in CCAA proceedings as a result of the restrictions on DIP lending under section 11.2 of the CCAA.  In addition, it provides further guidance as to how the courts may interpret the public policy exception under section 61(2) in the future.  It will be important to follow any further developments in this area as we see more foreign main proceedings recognized in Canada.

1Re Hartford Computer Hardware Inc., 2012 ONSC 964 [Hartford]

2Companies’ Creditors Arrangement Act, R.S.C. 1985, c. C-36, as amended.

3Hartford at para. 2.

4Hartford at para. 6.

5Hartford at para. 7-9, 13

6Hartford at para. 11.

7Hartford at paras. 12, 14.

8Hartford. at para. 12.

9Hartford at para. 15.

10Hartford at para. 16-18.

11Hartford at para. 17-18.