Debtor-In-Possession Financing In Canada
By Lisa S. Corne and David P. Preger of Dickinson Wright LLP
Posted: 18th April 2013 10:29Introduction
Debtor-in-possession (“DIP”) financing is an important tool used by insolvent companies undergoing reorganization proceedings under Canada’s Companies’ Creditors Arrangement Act (“CCAA”), or Bankruptcy and Insolvency Act (“BIA”). DIP loans permit insolvent debtors to obtain capital required in order to continue operations and pay certain creditors, on the theory that the debtor’s business is worth more as a going concern than would be the case if its assets were liquidated.
DIP Financing Pursuant to the CCAA
The CCAA is a statute designed to allow debtor companies with indebtedness of $5,000,000 or more to restructure. The CCAA is a flexible statute which allows debtors and creditors to come up with creative solutions to address the concerns of all stakeholders involved in the restructuring, including secured creditors, unsecured creditors, employees, and shareholders. The process is court supervised, and court approval is required for all major decisions affecting stakeholders.
One of the most important features of a DIP loan is that the DIP lender may be granted a priority charge over all of the debtor’s assets, in priority to existing secured creditors and statutory deemed trusts, provided that notice is given to the affected creditors. This priority charge does not secure debts incurred prior to the CCAA proceeding. DIP loans are frequently used to pay major suppliers on a go forward basis, and to pay the professionals assisting with the restructuring process.
Given the importance of DIP loans to the restructuring process, the CCAA was amended in 2009 in order to codify the circumstances in which courts will allow DIP loans, and now expressly requires that notice be provided to all creditors who are likely to be primed, before a priority charge to secure a DIP loan may be granted. In addition, if a debtor is acting in the role of fiduciary for any creditors (such as in the context of a debtor acting as a pension administrator), the debtor must notify the court and allow such creditors to be independently represented at the court hearing to seek approval of a DIP priority charge.
The amount of the DIP loan is assessed by the court in light of the debtor’s cash flow forecast over the course of the restructuring. There are a number of additional factors which the court must consider when deciding whether to grant a DIP loan, including:
(a) the period during which the company is expected to be subject to proceedings under the CCAA;
(b) how the company’s business and financial affairs are to be managed during the proceedings;
(c) whether the company’s management has the confidence of its major creditors;
(d) whether the loan would enhance the prospects of a viable compromise or arrangement being made in respect of the company;
(e) the nature and value of the company’s property;
(f) whether any creditor would be materially prejudiced as a result of the security or charge; and
(g) the monitor’s report, if any.
These factors are not exhaustive and must be interpreted in a broad and liberal fashion. In considering these factors, the court considers whether there is cogent evidence that the benefit of the proposed DIP financing clearly outweighs the potential prejudice to secured creditors. The court is concerned with the “broader picture,” not the negative effect on one creditor or another. Even in a situation where substantially all of the creditors oppose a DIP loan, such a loan may be approved where it furthers the remedial purpose of the CCAA and is likely to assist the debtor in making a viable compromise or arrangement.
DIP Financing Pursuant to the BIA
- The BIA is generally used to reorganize companies with debt in an amount below the $5,000,000 threshold required to qualify under the CCAA. In addition, the BIA applies to individuals who wish to make a proposal to creditors.
- The circumstances in which DIP loans may be approved and the factors considered by the courts in authorizing DIP loans are identical under the BIA and CCAA.
In today’s globalized economy, many companies operate in numerous jurisdictions simultaneously, and have subsidiaries which lend funds to one another, provide guarantees for one another on loans from third parties, or whose operations are so closely interrelated that it becomes difficult to separate the business activities of one from another. To take this new business reality into account, the CCAA and BIA now incorporate the United Nations Commission on International Trade Law (UNCITRAL) Model Law on Cross-Border Insolvencies regarding administration of cross-border insolvencies. The purpose of these provisions is to promote cooperation with foreign jurisdictions and to ensure fairness to creditors located in different countries.
If the operations of a multi-national business are sufficiently separate that two DIP loans can be provided, one in the foreign jurisdiction and one in Canada, then there is no issue of intermingling of assets, and the cross-border aspects of the restructuring have no bearing on the DIP. However, in most cases, there are inter-company loans and guarantees, and the multi-national business is run, through subsidiaries, on a consolidated basis. In such circumstances, DIP lending becomes more complicated.
In certain cases where Canadian and U.S. operations were closely integrated, Canadian courts have allowed the assets of a Canadian debtor to serve as collateral for a guarantee of a DIP loan to its U.S. parent company. In these cases, the Canadian company was dependent on the U.S. DIP loan in order to continue to operate as a going concern.
Factors to be considered when considering whether the assets of a Canadian debtor may be used to guarantee the obligations of a foreign related company include:
(a) the need for additional financing by the Canadian debtor to support a going concern restructuring;
(b) the benefit of the breathing space afforded by CCAA protection;
(c) the availability (or lack thereof) of any financing alternatives, including the availability of alternative terms to those proposed by the DIP lender;
(d) the practicality of establishing a stand-alone solution for the Canadian debtor;
(e) the contingent nature of the liability under the proposed guarantee and the likelihood that it will be called on;
(f) any potential prejudice to the creditors of the entity if the request is approved, including whether unsecured creditors are put in any worse position by the provision of the cross-guarantee;
(g) the benefits that may accrue to the stakeholders if the request is approved and the prejudice to those stakeholders if the request is denied; and
(h) a balancing of the benefits accruing to stakeholders generally against any potential prejudice to creditors.
Unlike in the United States, roll-up DIP loans (where the priority charge secures pre-filing debts) have never been a part of Canadian insolvency proceedings and run contrary to statutory provisions in the CCAA. Nevertheless, in a recent Canadian case, the court approved a “creeping roll-up DIP loan” which originated in Chapter 11 proceedings in the U.S. The court in this case decided that it would not second guess the decision of a court in the U.S., or declare the creeping roll up DIP contrary to Canadian public policy.
Lisa S. Corne is a Partner at Dickinson Wright LLP in Toronto. Ms. Corne has extensive experience in the practice of commercial insolvency and restructuring law, with particular expertise conducting real time litigation arising in the insolvency context. She regularly appears as counsel before the civil courts in Ontario and primarily before the Commercial List representing debtors, creditors, receivers, trustees, officers and directors in a wide variety of commercial matters, including cases under the Companies’ Creditors’ Arrangement Act, Bankruptcy and Insolvency Act, and Business Corporations Act.
David P. Preger is a Partner at Dickinson Wright LLP in Toronto. Mr. Preger’s primary focus is acting in complex Court-supervised real estate workouts, primarily for Court-appointed receivers and senior mortgage-lenders. In addition to bankruptcy, insolvency, real estate and security enforcement, his practice draws upon such varied areas as construction, land development, municipal, condominium, finance, environmental and aboriginal law. He regularly appears before the Commercial List of the Ontario Superior Court of Justice in Toronto. Many of the cases Mr. Preger has successfully argued have been reported in prominent reporting series including the Canadian Bankruptcy Reports and the Real Property Reports.