Mergers & acquisitions in a more uncertain world: using the Companies’ Creditors Arrangement Act
January 2015 | SPECIAL REPORT: DISTRESSED M&A AND INVESTING
Financier Worldwide Magazine
Perhaps the most useful, and commonly known, restructuring process available to insolvent entities in the United States is Chapter 11 of the US Bankruptcy Code. In Canada, however, there is more than one insolvency regime readily available for companies that find themselves in financial difficulty. Because of its flexibility, the one most commonly used in Canada for larger debtor companies is the Companies’ Creditors Arrangement Act (Canada) (CCAA). Use of the CCAA can benefit insolvent companies seeking to sell their assets or restructure while protected from creditors and investors interested in sponsoring the restructuring or buying assets on favourable terms without some of the procedural hurdles imposed in other M&A transactions.
Key benefits of the CCAA
Broad judicial discretion. CCAA judges have broad powers and discretion. This broad discretion can help to facilitate business combinations and asset sales that might otherwise not be possible.
Safe haven for directors of distressed companies. The directors of distressed companies face profound business difficulties, complicated by the need to act speedily within a thicket of fiduciary and statutory duties. Central to these difficulties is the challenge of continuing operations to preserve the ‘going concern’ value that would likely be lost in the event of liquidation. If the board is of the view that a sale of the business is the best choice, this may not be possible before liquidity is exhausted, unpaid creditors intervene or shareholder approvals and regulatory consents are obtained. The CCAA offers the board and management of troubled companies a number of protections. Firstly, it provides companies and their boards with a stay of proceedings. Secondly, they are given the authority to continue operations and to remain in control of the company. Thirdly, boards are granted time to work out a restructuring solution or arrange for an expedited sale. Finally, boards and management teams benefit from court approval of significant board decisions along the way.
Safe haven for acquirers of distressed companies. The financial difficulties of a target company can be equally challenging for a prospective investor or buyer. Investment in a distressed business may leave the investor ranking behind other creditors during any liquidation process. Furthermore, asset sales may be judicially overturned later as unfair to creditors. The CCAA offers a judicially blessed transaction, providing certainty and greatly reduced risk to those interested in purchasing distressed companies or their assets.
Asset sales under the CCAA. In the normal course of business, the sale by a Canadian corporation of all, or substantially all, of its assets requires the approval of the firm’s shareholders and may require other filings and approvals. The CCAA can facilitate or eliminate such approvals. Under the CCAA, the court has the authority to approve the sale of assets, pursuant to a vesting order, free and clear of any security, charge or other restriction and without a shareholder or even a creditor vote. The effect of the vesting order is that creditor claims to the purchased assets are converted into claims to the proceeds of sale, with the same pre-vesting order priorities. A CCAA order can also remove the need to obtain certain consents and other requirements for closing the transaction. For example, the CCAA authorises the court to assign contracts to an assignee, notwithstanding contractual restrictions on assignment, if certain preconditions are met. In addition, certain regulatory requirements under securities and other legislation can be avoided or ameliorated through the vesting order.
Stalking horse bids. The CCAA regime is flexible enough to allow for ‘stalking horse bids’. This approach is well-known in the US, but is relatively new in Canada. In this process, the debtor company enters into an agreement with a ‘stalking horse’ bidder for the sale of particular assets or the entire distressed business. An auction process is then undertaken to obtain the best offer possible. The stalking horse bidder provides a price that underpins the auction process. The stalking horse bidder enters the process knowing it may be outbid and thus negotiates compensation for its transaction costs, usually in the form of a break fee that it will receive if it loses. The stalking horse bidder resembles the ‘white knight’ in a takeover situation.
Share sales under the CCAA. An alternative to the sale of the debtor’s assets is a plan of arrangement involving the issuance of new shares of the company to the investor, with outstanding shares being diluted or extinguished. The cash, debt or equity securities contributed by the investor can then be distributed to the debtor company’s creditors pursuant to the plan of arrangement. Approval from the debtor company’s shareholders is not required, merely approval from the creditors – unless the court orders otherwise.
Debtor in Possession Financing (DIP). DIP financing is the provision of new financing to a debtor company seeking to restructure or sell its assets in the context of CCAA protection. The CCAA expressly allows the debtor company to apply for an order to permit a lender to lend new money during a restructuring, typically secured by a court-ordered charge that ranks ahead of existing secured creditors. DIP lending may be attractive to an investor as it provides access to opportunities that might not otherwise be available. If the lender is interested in ultimately acquiring the debtor’s business, providing DIP financing can give the lender a significant role in the course of the restructuring proceedings, through covenants in the DIP financing documents. This may be a critical advantage in positioning an investor for an acquisition. DIP financing can also be profitable by virtue of the attractive spread, with the risk moderated by a first-ranking security charge.
How the CCAA regime works
Initial application to court. To qualify to use the CCAA, a company must be insolvent and have liabilities of $5m or more. To initiate CCAA proceedings, the debtor company must make an application to court for an initial order granting it relief under the CCAA. Generally, an initial order does the following: it authorises the debtor company to prepare a plan of arrangement to put to its creditors; it imposes a stay of proceedings preventing creditors and suppliers from taking action against the debtor company in respect of amounts owing at the filing date; it prohibits the termination of contracts by parties doing business with the company; and it authorises the company to stay in possession of its assets and to continue to carry on business. It also appoints a licensed Canadian bankruptcy trustee as ‘monitor’, responsible for monitoring the business and affairs of the company during the proceedings. Finally, the order prohibits the company from making payments in respect of past debts, excluding a number of specific exceptions, such as amounts owing to employees.
The CCAA provides that an initial order may only impose a stay of proceedings for a period not exceeding 30 days, although the debtor company can apply for extensions. Such extensions are generally granted to permit the stay to continue until the company’s plan of arrangement is presented to creditors and approved by the court, or until a sale occurs.
If a plan of arrangement is proposed, in order for it to be considered binding on a class of creditors it must be approved by a majority in number of creditors representing two-thirds in value of the claims in the class, present and voting – either in person or by proxy – at the meeting of creditors. The CCAA does not contain ‘cram down’ provisions to impose a plan on a class that does not approve it. Therefore, aligning the interests and grouping the creditors together properly is often crucial to obtaining creditor approval. The CCAA sets out a ‘commonality of interest’ test for determining creditor classes.
Once approved by the creditors, the plan must also be approved by the court. The court will consider whether the plan fairly balances the interests of all of the company’s creditors, shareholders, employees and other stakeholders and whether the plan represents a fair and reasonable compromise that will permit a viable entity to emerge.
By taking the time to understand the CCAA regime, those looking to acquire the assets of distressed companies can do so relatively quickly and economically. Not only can assets be successfully acquired on good terms, but reasonable, relatively low risk returns can be obtained by providing DIP financing to insolvent companies. Significant changes in the economy call for significant changes in business dealings. The CCAA regime will be an important tool for many transactions in the current economic climate.
Sean Collins, James Gage and Warren Milman are partners at McCarthy Tetrault. Mr Collins can be contacted on +1 (403) 260 3531 or by email: firstname.lastname@example.org. Mr Gage can be contacted on +1 (416) 601 7539 or by email: email@example.com. Mr Milman can be contacted on +1 (604) 643 7104 or by email: firstname.lastname@example.org.
© Financier Worldwide
Sean Collins, James Gage and Warren Milman