Court Sheds Light on Prioritizing Insolvency Claims

The Ontario Court of Appeal (OCA) has released its decision in the case of Grant Forest Products Inc. v. The Toronto-Dominion Bank (Grant Forest). The decision is encouraging for lenders, reducing the uncertainty created by the recent Supreme Court of Canada (SCC) decision in Sun Indalex Finance, LLC v. United Steelworkers (Indalex). Grant Forest helps to clarify the circumstances in which pension claims will take priority over secured creditors in insolvency cases, narrowing the reach of Indalex in Ontario.

What You Need To Know

• The insolvency proceedings of Grant Forest Products Inc. gave rise to a priority dispute between pension claims and secured creditors.
• In Grant Forest, the Ontario Superior Court ruled that pension claims will not take priority over secured creditors when wind-up begins after the commencement of Companies’ Creditors Arrangement Act (CCAA) proceedings.
• The OCA has subsequently upheld the ruling in Grant Forest.
• The OCA also held that it is permissible to move between the CCAA and the Bankruptcy and Insolvency Act (BIA), subject to court approval—including in cases where that transition will result in the loss of the deemed trust under the Pension Benefits Act (PBA).

Background

Grant Forest Products Inc. (GFPI), along with its subsidiaries, was a company that manufactured strand board from facilities located in Canada and the United States. GFPI administered two defined-benefit pension plans that were later wound up. An Initial Order was made under the CCAA on June 25, 2009, which provided for a stay of proceedings to enable the restructuring of various assets of GFPI. As at the date of the Initial Order, neither of the two relevant pension plans was being wound up. An asset sale occurred during the course of the stay of proceedings under the CCAA between 2010 and 2011.

In August and September 2011 (following the asset sale), the Court granted Orders allowing the initiation of a wind-up of the two relevant pension plans. These Orders directed the Monitor to hold back from distribution of the asset sale proceeds an amount estimated to be the wind-up deficit. Notwithstanding the holdback, the first lien lenders were repaid in full from the asset sale proceeds. The issues of priority and deemed trust then arose as between the plan administrator and the second lien creditor in respect of the holdback amount. A further issue also arose as to whether the stay of proceedings should be lifted to allow the second lien creditor to proceed with an outstanding petition in bankruptcy and seek a bankruptcy order under the BIA.

A Brief Note on Indalex

In the case of Indalex, the SCC held that, upon the wind-up of a pension plan, the Pension Benefits Act (Ontario) (the PBA) statutory deemed trust applies not only to the employer’s normal cost and special contributions to the plan prior to the wind-up date, but also to the entire wind-up deficiency. In Indalex, the SCC was dealing with a plan that had been wound up prior to the commencement of the CCAA proceedings; the SCC found that the priority afforded to such deemed trust claims arises only after a plan is wound up.

In Indalex, a question also arose as to the priority of a deemed trust. The SCC held that a CCAA filing does not in and of itself alter priorities, but that a CCAA filing does allow a judge to issue orders that can have the effect of altering priorities. This expansion of the deemed trust to include the wind-up deficiency was seen to have a potentially significant adverse effect on the claims of secured creditors. As a result, lenders, pension administrators, and companies contemplating secured transactions or facing financial distress have been waiting for post-Indalex decisions to clarify the implications of that case.

Decision of Justice Campbell in Grant Forest

On September 20, 2013, Justice Campbell of the Ontario Superior Court of Justice held that the second lien creditor had priority over the holdback funds, disagreeing with the pension administrator’s argument that a deemed trust had arisen pursuant to the PBA. Of primary importance to Justice Campbell’s decision was the fact that the two relevant pension plans had not begun wind-up at the time of the Initial Order. Further, based on the language in the Initial Order, which permitted, but did not require, the payment of pension contributions, Justice Campbell held that federal paramountcy dictated that the Initial Order—under a federal statute—took priority over the PBA.

Justice Campbell’s 2013 decision also left open a question relating to flipping priorities when an insolvency proceeding transitions from the CCAA to the BIA. Specifically, Justice Campbell referred to section 67 of the BIA as a "problem" in that it would flip the priority of the pension deficit as compared to the CCAA. He permitted the second lien creditor to proceed with a petition in bankruptcy, but left open the question of why such a petition was necessary in the circumstances.

Justice Campbell’s decision in Grant Forest suggested that lenders could take comfort despite the SCC’s decision in Re Indalex: his decision made clear that pension claims will not take priority over secured creditors when wind-up begins after the commencement of CCAA proceedings.

The decision was appealed by the Ontario Superintendent of Financial Services, which took the position that the wind-up deemed trust had priority by virtue of the PBA and the Personal Property Security Act (Ontario).

OCA Decision

The OCA, in unanimously upholding Justice Campbell’s decision, went a step further in clarifying the priorities as between pension claims and secured creditors, and in analyzing the ability to move from the CCAA to the BIA.

On the issue of priorities, the OCA distinguished the case from Indalex and stated that Indalex did not assist the Superintendent’s position since the plan in Indalex had been wound up before the commencement of insolvency proceedings. Although the OCA did not expressly affirm Justice Campbell’s conclusion on this point (i.e., that the PBA deemed trust priority only applied to plans that are wound up before the commencement of insolvency proceedings), they did not question his findings in any way.

On the issue of the CCAA/BIA priority flip, the OCA held that it is a discretionary decision as to whether a bankruptcy petition should be permitted. The OCA was clear that moving between statutes is always permissible, subject to the approval of the court. Here, since there was no bad faith on the part of the petitioner, the OCA held that Justice Campbell had committed no error in principle in permitting the bankruptcy petition.

Conclusions

Following Indalex, there was concern regarding the extent of the priority available to wind-up deficits in Ontario. The Court in Grant Forest limited Indalex to cases in which wind-up is commenced prior to insolvency proceedings. This should give comfort to secured lenders, especially where secured credit facilities contain covenants restricting the commencement of such wind-up proceedings. In addition, the OCA was clear that it is permissible to move between the CCAA and the BIA, subject to court approval, even where such transition will result in the loss of the deemed trust under the PBA. This means that, where advantageous, parties can opt for the BIA’s structured distribution scheme rather than proceeding under the CCAA, as long as such election is done in good faith. This is a very important tool available to lenders, where the circumstances are appropriate, to combat uncertainty in priority disputes.