It’s not often that judges refuse to put a restructuring plan to a creditor vote, but that’s what happened in January when Ontario Superior Court Regional Senior Justice Geoffrey Morawetz threw a wrench in Target Canada’s plan to pay creditors under the Companies’ Creditors Arrangements Act.
Putting it to a vote “would only result in a waste of time and money,” he wrote, when sending the parties back to the negotiating table.
In early March, a settlement was reached with the landlords and it’s expected a new plan will be presented and voted on later this spring.
The Target case sends a warning to restructuring experts that while the CCAA regime is flexible, there are limits to which a court will allow plan sponsors to run roughshod over creditors who hold guarantees and existing court orders for the sake of expediency and arriving at a deal.
It also shows the importance of negotiating upfront to protect guarantees.
Target made headlines in January 2015, when the Canadian arm of the retailing giant filed for creditor protection about four years after the company purchased the leases of the old Zellers Inc. stores for $1.8 billion. Target spent a total of $7 billion entering Canada, its first foray outside the United States.
At the time of filing, the Canadian operation, which was represented in the CCAA filing by Osler Hoskin & Harcourt LLP, had grown to 133 stores and employed 17,600 people.
However, the Canadian stores never lived up to sales expectations, averaging losses in 2013 and 2014 of $200 million a quarter.
A poor supply chain, expanding too quickly, pricing and product issues, and lack of an online presence were to blame.
With losses expected to continue for as many as five more years, Target tossed in the towel.
Landlords were out millions of dollars; however, many had an ace up their sleeve.
Some had negotiated guarantees from U.S. parent Target Corporation, which was represented by Davies Ward Phillips & Vineberg LLP, while others had indemnities that flowed back to the original leasee, Zellers Inc., which had been acquired by Hudson’s Bay Co.
Following the initial order, a group of landlords fought tooth and nail to amend the initial order to protect their guarantees.
“The first thing I thought of was how do I protect my client’s guarantees,” says Linda Galessiere, a litigator at McLean & Kerr LLP, who represented a group of REITs that were landlords caught up in the CCAA process, including some with guarantees.
A month later, the order was amended to include provision 19A, a critical move. That provision held that the landlords’ guarantees would not be affected by the plan. In exchange, the landlords agreed not to force Target to liquidate under the Bankruptcy & Insolvency Act.
The claims procedure order was also settled after prolonged negotiations among creditors, including the landlords, and it provided for a comprehensive claims review process that would be determined by a judge of the Commercial List.
That paved the way for Target to maximize the value of its leases for creditors under a sales process, which saw retailers, such as Wal-Mart Canada, Lowes, and Canadian Tire, pick up leases.
However, not all leases were sold and a number were disclaimed. When the windup plan was filed with the court in November 2015, it was cleverly structured to win over creditors, partly at the expense of landlords holding guarantees.
First, the plan would see “affected creditors” receive between 75 and 85 cents on the dollar, with the parent Target Corporation subordinating upwards of $5 billion in intercompany claims.
The plan also proposed that affected creditors would be lumped into a single class for voting purposes, which would avoid the problem of one class of creditors having the power to veto the plan.
It also said that creditors owed less than $25,000 would be paid out in full. They amounted to a sizable group, which would help with the voting numbers required to pass a plan.
However, it also proposed a formula for determining landlord claims for restructuring their premises.
It was an enhanced version of the scheme set out in the Bankruptcy and Insolvency Act, which would see landlords get an additional year of rent paid for by Target Corporation, more than they would under the BIA.
However, in exchange, U.S. parent Target Corporation wanted releases covering not only itself but also third parties such as Zellers and HBC. A group of objecting landlords cried foul, arguing that the plan breached the court order because it messed with their guarantees and the claims procedure order.
They challenged Target’s motion to put the plan to a vote.
That set up the showdown before Morawetz, which pitted the Target entities, the monitor, which supported the plan and was represented by Goodmans, and various other creditors against a remaining group of landlords holding disclaimed leases worth millions of dollars in claims.
The landlords argued the plan amounted to a violation of the earlier court orders and if approved would undermine the CCAA process by creating uncertainty and an unreliable process. The Target applicants argued that “affected creditors should be allowed to vote and express their views.”
Morawetz, however, said the CCAA process is “one of building blocks.” Stays are granted and orders are issued, he said.
“It is essential that court orders made during the CCAA process are respected,” he said, noting that the amendment order protecting the guarantee was “heavily negotiated by sophisticated parties.”