Ontario Court holds that a recent former auditor cannot act as CCAA Monitor in the absence of extenuating circumstances

In Re Trees Corporation et al., 2024 ONSC 30 (Trees), the Ontario Superior Court of Justice (Commercial List) (the Court) became the first court to consider in detail section 11.7(2) of the Companies’ Creditors Arrangement Act (CCAA), which provides that a Monitor shall not be a firm that has acted as auditor of the applicant within the two-year period prior to commencement of a CCAA proceeding. The Court took a restrictive view of this provision, refusing to permit a restructuring firm to act as Monitor because its affiliate had acted as the auditor of one of the debtors within that two-year period. It is not enough that the firm is independent, does not have a real or perceived conflict of interest, or that there is no reasonable apprehension of bias—these are baseline requirements for the appointment of any Monitor. Rather, section 11.7(2) of the CCAA requires that there be extenuating or unique circumstances to justify such an appointment.

What you need to know

• Section 11.7(2) of the CCAA. Section 11.7(2) of the CCAA provides that the court’s permission is required for a restructuring firm to act as a Monitor if that firm was, among other things, “the auditor, accountant or legal counsel, or a partner or an employee of the auditor, accountant or legal counsel of the company” at any time during the preceding two years.
• Corporate separation may not overcome the rule. Prior to Trees, it was unclear whether section 11.7(2), by its plain wording, applied only where the proposed Monitor itself acted as the debtor company’s auditor rather than an affiliate of the proposed Monitor. The Court’s decision extends section 11.7(2) to a circumstance in which the proposed Monitor has not acted as auditor but, instead, an affiliate of the proposed Monitor has acted as auditor.
• Extenuating or unique circumstances are required to act. The Court held that the independence of the proposed Monitor, the lack of any real or perceived conflicts of interest, and the absence of a reasonable apprehension of bias do not satisfy the requirements of section 11.7(2) so as to make it appropriate to appoint such person as Monitor—rather, these are baseline considerations for the appointment of any party as Monitor. The appointment of an auditor or a former auditor as Monitor is an exception to the rule and should be permitted under section 11.7(2) only where there are extenuating or unique circumstances that warrant the appointment.
• Potentially high bar to overcome. The Court warned that choosing a former auditor as the proposed Monitor cannot be justified by a factual matrix created by the Applicant that the proposed Monitor now has, by reason of having been involved in preparations for CCAA proceedings, obtained the knowledge to perform the role or that switching the proposed Monitor at this point would involve unnecessary costs or delay. These do not amount to extenuating or unique circumstances. The lack of opposition to the proposed Monitor is also not determinative. Although no party objected to the proposed Monitor in the Trees case, the Court considered that service of materials had occurred over the seasonal holidays, and some parties may be unaware of the proceedings. The Court observed that the grant of security to a lender that occurred during the time that the proposed Monitor acted as auditor—although not presently or expected to be an issue in the case—may require review in the future, and this too was a consideration for the Court.

The details

Background

Trees Corporation and its subsidiaries (Trees) operate retail stores that sell cannabis products and accessories to adult-use consumers from leased retail premises in British Columbia and Ontario. In December 2023, the Court granted Trees an initial order under the CCAA and appointed a restructuring firm as the Monitor, but subject to consideration at the “comeback hearing” as to the appropriateness of this party continuing as Monitor.

The Monitor had disclosed in its pre-filing report that one of its affiliates previously acted as the auditor for one of the Trees applicants. The affiliate resigned as auditor approximately 19 months prior to the CCAA application—within the two-year restricted period under section 11.7(2) of the CCAA. The final period that the affiliate had audited was the year ended December 31, 2021, and subsequent financial statements had been prepared for the debtors since that time and were audited by a new audit firm. The proposed Monitor had also put in place ethical walls and similar measures between it and its affiliate as part of its engagement. There were no known conflicts of interest, and no party opposed the appointment of the proposed Monitor at the initial hearing or the comeback hearing.

At the comeback hearing, the Court considered whether to grant the Monitor permission to continue to act as Monitor in light of its affiliate’s previous auditing engagement.

Key issue

The key issue was whether the Court should permit the Monitor to continue acting as Monitor where its affiliate had acted as auditor for one of the debtors within two years of the CCAA application in light of the restriction in section 11.7(2) of the CCAA.

The Court’s decision

The Court refused to grant the proposed Monitor permission to continue acting as Monitor following the comeback hearing.

Prior to the Trees decision, numerous courts (including particularly in Québec) had taken a permissive approach to the restrictions set out in section 11.7(2) of the CCAA and permitted former audit firms to act as Monitor. However, these cases did not contain any analysis of section 11.7(2) or reasons on point to support these decisions. It seems that courts have, to date, permitted former auditors to act as Monitor where there is no conflict of interest and no concerns that the auditing role would result in a reasonable apprehension of bias, real or perceived.

Trees now sees this approach rejected. More is required if the Court is to give its permission under section 11.7(2). The Court held that there must be extenuating or unique circumstances that would cause the Court to exercise its discretion to appoint the former auditor as Monitor. In other words, rather than permitting the recent former auditor to act as Monitor in the absence of a specific concern or reason it should not, the Court held that a Monitor should not be permitted to act unless there is a specific and compelling reason why it should.

The Court held that there were no extenuating or unique circumstances present in Trees. The Court rejected arguments that the Monitor had acquired extensive knowledge about the debtors’ business from its pre-filing activities, holding that such arguments should be treated with “extreme caution”. Likewise, the Court dismissed assertions that replacing the Monitor would only serve to increase professional costs to the detriment of the debtors, the restructuring process and its stakeholders, noting that it was the Applicants who made the decision to engage the Monitor prior to their CCAA filing. The Court also noted that, due to the comeback period taking place over the holiday season, service to affected parties had been limited. In short, where an Applicant proposes a Monitor that is a recent former auditor, its arguments that replacing its choice of Monitor after the commencement of a CCAA proceeding would be problematic are not compelling and do not establish extenuating or unique circumstances that would justify appointing the former auditor as Monitor.

Finally, the Court applied an expanded interpretation of section 11.7(2), determining that the auditor restriction can apply not only where a Monitor has acted as the debtor’s auditor but where its affiliate has done so as well. The Court did not provide guidance as to whether affiliates will engage this rule in all circumstances, or whether there are some characteristics of the relationship between the proposed Monitor and an affiliate that might make section 11.7(2) less or more likely to be triggered.

Implications

The Court’s decision in Trees has potentially significant implications for debtors and restructuring professionals alike. It is not enough that a former auditor acting as Monitor is not problematic in the facts of a case; rather, the parties must establish that extenuating and unique circumstances exist. Although the Court did not give an example in its reasons of what extenuating or unique circumstances might justify appointing a recent former auditor as Monitor, it is difficult to conceive of scenarios in which another firm acting as Monitor is not possible or would be highly problematic.

Knowing that the courts may reject a proposed former auditor as Monitor in the absence of extenuating or unique circumstances—with the costs, delays and complications arising from having to find another firm to act as Monitor post-CCAA commencement—will likely discourage distressed companies from attempting it given the number of other firms undoubtedly able and willing to act. Section 11.7(2) clearly does not bar outright a recent former auditor from acting as a Monitor (something the Court in Trees affirmed), but it remains to be seen what extenuating or unique circumstances might justify such an appointment.