Re Indalex: Canada's Top Court Provides Some Clarity for Insolvent Companies with Pension Deficiencies

On February 1, 2013, the Supreme Court of Canada in Re Indalex allowed in part the appeal of Sun Indalex Finance and, in doing so, delivered guidance to companies entering into restructuring proceedings.

Background

In 2009, Indalex Limited obtained creditor protection under the Companies’ Creditors Arrangement Act (CCAA) and obtained debtor-in-possession (DIP) financing under a court order granting a super-priority charge in favour of the DIP lenders. The proposed distribution of the sale proceeds of Indalex to the DIP lenders was opposed by the beneficiaries of the two defined benefit pension plans that were sponsored and administered by Indalex, one for salaried employees and one for executive employees (together the Plans). The CCAA court dismissed the claims of the Plans’ beneficiaries, a decision that was then appealed. The Ontario Court of Appeal released its decision on April 7, 2011, holding that the deemed trust and breach of fiduciary duty claims of the Plans’ beneficiaries should be paid in priority ahead of the court-ordered super-priority charges. The relevant facts of Re Indalex and the Ontario Court of Appeal decision are discussed in our bulletin dated April 12, 2011.

The Supreme Court of Canada Decision

In overturning the ruling of the Ontario Court of Appeal, the majority of the Supreme Court of Canada focused on the same three principal issues as the Ontario Court of Appeal decision, with some different results.

1. Scope of the Deemed Trust Under the PBA

The Ontario Court of Appeal held that when a pension plan has been wound up, the deemed trust created under the Ontario Pension Benefits Act (PBA) covers the entire windup deficiency of the plan, not just the amounts owing in respect of the employer’s normal cost contributions and special contributions prior to the windup date.

The majority upheld the decision of the Court of Appeal on this point, stating that the remedial purpose of the deemed trust provisions under the PBA favours an inclusive approach. Therefore, upon windup of a plan, the statutory deemed trust applies not only to the unpaid normal cost and special contributions but also to the entire windup deficiency. Given that this ruling was limited to the plan that was terminated (the plan for salaried employees) and not the plan whose windup was not completed as at the date of the company’s asset sale transaction (the plan for executive employees), it appears that the priority afforded to such claims arises only when a plan is wound up.

2. Priority of the Deemed Trust (Before and After CCAA Filing)

The question then turned to the position of the statutory deemed trust in terms of priority ranking. The Supreme Court held that a CCAA filing does not alter priorities, but that it does allow a judge to issue orders that can have the effect of altering priorities. All judges agreed that the super-priority for DIP lenders granted under the CCAA order will trump the deemed trust under the PBA by application of the doctrine of federal paramountcy (that doctrine provides that when provincial and federal laws conflict, the federal law will apply). The Court unanimously reinstated the trial judge’s grant of priority for the DIP financing over the PBA deemed trust.

The Ontario Personal Property Security Act provides that a deemed trust arising under the PBA has priority over other security interests in the debtor’s  accounts and inventory. So, while the deemed trust will not have priority over a DIP charge, it will, upon the windup of a plan, have priority over the security interests of other secured creditors in the debtor’s accounts and inventory. Depending on the debtor, the expansion of the deemed trust to include the windup deficiency could have a significant effect on the claims ranking ahead of secured creditors.

3. Fiduciary Duty

The Ontario Court of Appeal held that Indalex breached the common law and statutory-based fiduciary duties owed to pension plan beneficiaries, giving rise to a constructive trust over the sale proceeds in favour of the plan beneficiaries.

The majority of the Supreme Court held that a conflict of interest can arise when an employer also chooses to be the administrator of a company-sponsored pension plan. However, the difficulty lies not in the conflict, but in the failure to address the conflict. In this case, the majority of the Supreme Court held that the commencement of CCAA proceedings itself was not a breach of fiduciary duty to the pension beneficiaries. The breach of fiduciary duty occurred only when the employer failed to ensure that the pension beneficiaries had an opportunity to be fully represented at the hearing for the order approving DIP financing with priority over the pension claim. The employer could have met its fiduciary duty by giving plan beneficiaries reasonable notice of the DIP financing motion. The majority then held that to impose a constructive trust in response to the breach of fiduciary duty would have been an inappropriate remedy.

Conclusion

The impact of the decision will be felt over the coming months. Lenders, pension administrators, and companies contemplating entering into secured transactions or facing financial distress need to be aware of the effect of the SCC’s judgment on their future business decisions.