Supreme Court of Canada rules on pension priorities in insolvencies
April 2013 | PROFESSIONAL INSIGHT | BANKRUPTCY & RESTRUCTURING
Financier Worldwide Magazine
On 1 February 2013, the Supreme Court of Canada (SCC) released its decision in Sun Indalex Finance, LLC v. United Steelworkers (Re Indalex). In its 160 page decision, the SCC confirmed that a court-ordered debtor-in-possession (DIP) charge had priority over a deemed trust (akin to a statutory security interest) securing the debtor’s obligation to fund the wind-up deficiency arising on the wind-up of a defined benefit registered pension plan. However, the DIP charge priority issue was only one of four critical issues considered by the SCC. This article explains the four key findings of the SCC but is not intended to be a comprehensive review of the decision.
In April 2009, Indalex Limited (Indalex) and certain related entities sought and obtained protection, pursuant to the Companies’ Creditors Arrangement Act (CCAA), from the Ontario Superior Court of Justice [Commercial List] (the CCAA Court). The CCAA is the principal statute for the reorganisation of large commercial entities in Canada. Other than notice to the existing lender, the CCAA application was made without notice to other stakeholders. Indalex’s parent company (Indalex US) and its related US entities also sought protection pursuant to Chapter 11 of the US Bankruptcy Code, on an urgent basis. Shortly after filing for CCAA protection, Indalex sought and obtained DIP financing, secured by a superpriority DIP charge, ranking in priority to all liens and encumbrances including deemed trusts.
At the time of filing, Indalex was the corporate sponsor and plan administrator of two registered defined benefit pension plans commonly known as the ‘Salaried Plan’ and the ‘Executive Plan’. Both the Salaried Plan and Executive Plan were in an underfunded position. At the time of filing, the Salaried Plan was in the process of being wound up. The Executive Plan had not been wound up. Although the union representing certain pension plan beneficiaries was provided with short notice, pension plan beneficiaries were not given direct notice of Indalex’s motion seeking the granting of the DIP charge. After the sale of Indalex’s assets a priority dispute arose as to the entitlement of proceeds of sale. Certain pension beneficiaries asserted they had priority over Indalex US, which became a beneficiary to the DIP charge after making a guarantee payment to the initial DIP lender. At first instance, the DIP charge was held to have priority. At the Ontario Court of Appeal, the pension claim was held to have priority. The case eventually made its way to the SCC.
The SCC made the following key findings.
Scope of the deemed trust
The threshold issue decided by the SCC was whether the statutory deemed trust provided for in the Pension Benefits Act (Ontario) (PBA) secured the obligation to fund the entire wind-up deficiency of a defined benefit pension plan or secured only the unpaid normal cost contributions and special payments as at the wind up date.
By way of a 4-3 majority, the SCC upheld the finding of the Ontario Court of Appeal that the deemed trust created by the PBA extends to the obligation of a pension plan sponsor to fund the pension wind-up deficiency on the wind-up of a defined benefit pension plan. Accordingly, the deemed trust securing the wind-up deficiency of a defined benefit pension plan has priority over the claims of secured creditors in inventory and receivables. The deemed trust also has priority over unsecured creditors. If the pension plan was not wound up, however, no deemed trust could arise.
Priority of DIP charge
The Ontario Court of Appeal had found that although the CCAA Court had the power to grant a DIP charge that would supersede the deemed trust, the DIP charge in this case did not have that effect because the doctrine of federal paramountcy was not ‘invoked’. In short, the doctrine of federal paramountcy provides that where validly enacted federal law conflicts with validly enacted provincial law, or where complying with provincial law would frustrate the purpose of the federal law, the federal law governs.
All seven justices held that a court supervising a proceeding under the CCAA has authority to grant a DIP charge that has priority over the PBA deemed trust. The SCC concluded that to the extent valid orders issued under the federal CCAA conflict with the provisions of applicable provincial legislation, the orders under the federal legislation take precedence and it is not necessary for a party to ‘invoke’ the doctrine of federal paramountcy.
All seven justices held that where there is a conflict of interest between the debtor’s corporate role and its role as administrator of the company’s pension plan, the conflict must be addressed so as to avoid a breach of its fiduciary duty to the pension plan beneficiaries. The SCC held that Indalex breached its fiduciary duty to the pension beneficiaries primarily because the beneficiaries were not given notice prior to Indalex seeking the DIP charge in priority to their claims. The majority disagreed with the Ontario Court of Appeal’s conclusion that the very act of seeking relief under the CCAA without notice to the pension plan beneficiaries was a breach of fiduciary duty.
The SCC held that the Court of Appeal erred in imposing a constructive trust, granting the pension beneficiaries priority over the DIP charge. The court found that a remedial constructive trust for a breach of fiduciary duty is only appropriate if the wrongdoer’s acts give rise to an identifiable asset which it would be unjust for the wrongdoer (or sometimes a third party) to retain. Indalex’s breach – the failure to meaningfully address the conflicts of interest that arose during the CCAA process by providing greater notice – had no adverse impact on the pension plan beneficiaries in the sale approval which gave rise to the asset in question (i.e., the remaining proceeds of sale). Indalex had a limited universe of options in light of its financial distress and, through their own initiative, the interests of the plan beneficiaries were fully represented and carefully considered before the sale was approved. Imposing an equitable remedy that gave the pension plan beneficiaries full recovery of their claims, at the expense of another creditor constituency, was found to be unreasonable in the circumstances.
Implications for commercial lenders and debtor companies
Unfortunately, the Indalex decision has resulted in material risks for commercial lenders (whether secured or unsecured) to debtors with underfunded defined benefit pension plans, as well as governance challenges for sponsors and administrators of registered pension plans. How these risks can be managed remains to be seen. On the other hand, the SCC did provide needed certainty which will facilitate DIP financing in Canada in finding that the court ordered DIP charge has priority over the PBA deemed trust. As stated recently by the Ontario Court in Re Timminco, no commercially motivated lender could be expected to advance funds without the priority afforded by the DIP charge. The SCC recognised this reality and, in doing so, supported the stability, certainty and predictability that are vital for the financing of a successful CCAA restructuring.
Linc Rogers and Jeff Sommers are partners at Blake, Cassels & Graydon LLP. Mr Rogers can be contacted on +1 (416) 863 4168 or by email: firstname.lastname@example.org. Mr Sommers can be contacted on +1 (416) 863 2534 or by email: email@example.com.
© Financier Worldwide
Linc Rogers and Jeff Sommers
Blake, Cassels & Graydon LLP