A new provision in the Companies’ Creditors Arrangement Act came into force in September requiring court approval for any disposition of assets by a CCAA-protected company where the transaction was “outside of the ordinary course of business.”
The Industry Canada briefing book on the provision, s. 36, cites its purpose as intending “to provide the debtor company with greater flexibility in dealing with its property while limiting the possibility of abuse” by phoenix corporations.
Such abuses arise in the context of owners who engage in serial bankruptcies. These individuals incorporate businesses and then cause them to become bankrupt.
The same person purchases the assets at a discount and starts a new business using them. As a result, the owner continues with what amounts to the original business while leaving creditors unpaid.
The difficulty is that s. 36 is cast in very broad terms capable of capturing dispositions that are insignificant in relation to the assets of the entire enterprise.
“The provision is unfortunate in its scope, so the judgments interpreting it tend to be very practical,” says Mario Forte of Ogilvy Renault LLP. “Basically, judges have been working around it rather than putting people through the sausage maker of court approval with respect to every disposition in a restructuring.”
But when a disposition is to an entity related to the debtor, judges have more reason to be circumspect, even more so when the transaction is a large one.
That’s the situation Ontario Superior Court Justice Sarah Pepall faced in the CanWest restructuring. In November, CMI Entities, a group of companies that were under CCAA protection, asked Pepall to approve a transition and reorganization agreement among the various CanWest assets, only some of which were under bankruptcy protection. The idea was to restructure the enterprise by transferring the assets of The National Post to a new entity.
CMI, supported by the monitor, described the transactions involved as “inter-entity arrangements” and asked Pepall to declare that the agreement represented an internal corporate reorganization that wasn’t subject to s. 36. Such a reorganization, it argued, was within the ordinary course of business of the insolvent enterprise and therefore didn’t engage the provision.
But, Pepall noted, not every internal corporate reorganization escaped the purview of s. 36.
“Indeed, a phoenix corporation to one may be an internal corporate reorganization to another,” she wrote.
In this case, however, the businesses of the Post and the parent of the new subsidiary were “highly integrated and interdependent.” The current arrangement reflected an anomaly that hindered the success of the enterprise and that the agreement aimed to remedy.
“The transition and reorganization agreement is an internal reorganization transaction that is designed to realign shared services and assets within the CanWest corporate family so as to rationalize the business structure and to better reflect the appropriate business model,” Pepall noted.
It would therefore be “commercially unreasonable” to require the parties to engage in the sale approval process contemplated by s. 36, including putting the Post up for grabs by third parties, before permitting a realignment.
“In these circumstances, I am prepared to accept that s. 36 is inapplicable,” Pepall concluded.
But Pepall went on to say that even where the provision didn’t apply, court approval was still necessary when the disposition was to a related person and there existed an apprehension that it wasn’t in the ordinary course of business. But even if the court decided the transaction was so, it could still consider the criteria in s. 36 in assessing whether it was fair.
In the CanWest case, the agreement was the product of extensive negotiations and consultation, and the major creditors all supported it. At the same time, it preserved value for stakeholders and maintained employment.
“I am satisfied that the proposed transaction does facilitate the restructuring and is fair and that the transition and reorganization agreement should be approved,” Pepall ruled.
But Edward Sellers of Osler Hoskin & Harcourt LLP, who is part of the team of lawyers representing CMI, is disappointed with the ruling.
“We hoped that the court might be prepared to read down the scope of s. 36 to definitively exclude desirable, good-faith steps taken in effecting a reorganization,” he tells Law Times.
“But the court wasn’t prepared to do that, and the ruling leaves us with certain challenges because it’s not infrequently that a company in CCAA protection has to move things around to get the deal done.”