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The Arrangement of Nemaska Lithium Inc. is the first reverse vesting order (RVO) to be granted under the Companies’ Creditors Arrangement Act (CCAA) after a contested hearing1. The Québec Superior Court provided forceful reasons in favour of RVOs as an innovative and creative solution to complex contemporary economic problems that permit the Court to meet the objectives of the CCAA for the benefit of all stakeholders.
What you need to know
The decision provides increased certainty and guidance for companies and bidders contemplating RVOs under the CCAA as a means to effect a restructuring transaction.
RVOs are an innovative alternative to conventional vesting orders and provide continuity for businesses requiring relief from the creditors.
Unlike a traditional vesting order (in which a company’s assets are transferred to a purchaser and its liabilities are left behind), an RVO permits the assets of the company to remain where they are—instead, the liabilities of the company are transferred to a “residual corporation”.
RVOs allow the corporate entity to continue in the hands of a new investor via share deals rather than asset sales, preserving existing rights such as permits and operating agreements and leaving employees where they are, while transferring unwanted assets and liabilities to the newly-incorporated residual corporation (with sale proceeds also transferred to this entity for distribution to the creditors, whether under a plan of arrangement or in an ensuing bankruptcy).
This mechanism offers significant advantages for distressed businesses in industries such as the mining industry that have businesses, contracts, and assets that are complex to transfer—including permits and approvals and agreements with Indigenous peoples—and that have attractive tax assets or other attributes that may be lost in assets sales.
Several RVOs have been made under the CCAA recently, but this is the first occasion on which the Court has made an RVO after hearing extensive objections from affected stakeholders.
Québec Superior Court rejects arguments against RVOs
The Superior Court of Québec granted the RVO and approved the transaction proposed by Nemaska Lithium Inc. (the company) after a court-approved sale or investment solicitation process (SISP). In his reasons accompanying the RVO, Mr. Justice Louis J. Gouin of the Commercial Division touted the flexibility and discretion that the Court enjoys under the CCAA to address complex situations. This includes making use of creative and innovative mechanisms such as the proposed RVO in order to preserve the business as a going concern in an efficient manner that benefits stakeholders as much as possible. The judge underlined that the alternatives to the proposed transaction, including bankruptcy, could potentially be catastrophic for all stakeholders.
The Nemaska arrangement proceedings under the CCAA
Nemaska Lithium has been developing lithium deposits in the James Bay region of Québec, as well as a plant to transform the extracted hard rock into high purity lithium hydroxide using proprietary technology. After attempting to find new investment by way of an arrangement under the Canada Business Corporation Act, the company entered into CCAA protection in December 2019 and began the SISP. The successful bid at the conclusion of the SISP was a form of credit-bid put forward by Nemaska’s principal secured creditor (Orion)2 and by Investissement Québec (IQ) and The Pallinghurst Group (PG).
Under the proposed transaction and RVO, IQ and PG (the sponsors) would take ownership of the business and assets of Nemaska Lithium, including the mine, free and clear of all encumbrances. Most of the existing employees of the business would continue in place, and the agreement negotiated with Indigenous groups near the mine (the Cree Nation of Nemaska) would also continue. The sponsors would invest up to $600,000,000 into the business. At the conclusion of the transaction, the sponsors would be shareholders of Nemaska Lithium, which would exit the CCAA proceedings, and would assume $146,500,000 of liabilities, including paying the secured claim of Orion. Certain assets and liabilities would be excluded from the RVO. The excluded assets and liabilities would be transferred to new corporate entities (New ParentCo and ResidualCo) made subject to the CCAA proceedings, and certain proceeds of sale would be available for distribution to the remaining creditors pursuant to a plan of arrangement to be approved by those remaining creditors3. As Nemaska Lithium is a public company, the existing shareholders would become shareholders of New ParentCo through a share exchange approved by the Court (i.e., to facilitate the sponsors’ acquisition of all of the shares of Nemaska Lithium).
Objections to the RVO
Victor Cantore, a former consultant or employee of the company, objected to the RVO. Mr. Cantore asserted a claim based upon the company’s agreement to pay him a net smelter return royalty in consideration for mining claims that he had transferred to the company in 2009. Mr. Cantore argued that his claim was in the nature of a “real right” (the civil law equivalent of an in rem right) and not merely an unsecured personal claim, but that dispute was deferred to a later stage of the process. Nevertheless, Mr. Cantore objected in principle to the granting of the RVO as being outside of the powers of the Court under the CCAA.
Amongst other objections, Mr. Cantore argued that the Court’s powers to issue vesting orders are limited to the sale or disposition of assets. Because the assets remain with the company in an RVO but are purged of all encumbrances (which are “vested” in the residual company), there is no sale or disposition. Mr. Cantore also objected to the RVO taking place outside of and prior to a plan of arrangement, depriving creditors of the opportunity to vote on the transaction approved in the RVO. He also asserted that the CCAA cannot be applied to the new residual entity to which the excluded assets and liabilities are to be transferred.
Reasons of the Superior Court of Québec approving the RVO
Gouin J. begins his reasons by describing the evidence about the mechanics of the proposed transaction, which he says convinced him that an RVO can serve a legitimate purpose and be beneficial to all parties. He characterizes the SISP order as the backdrop or cornerstone for the proposed transaction and RVO, which the Court must either accept or reject (not having the authority to modify it).
The judge finds support for the legal basis of the RVO under section 36 CCAA in the decision of the Supreme Court of Canada in 9354-9186 Québec Inc. v. Callidus Capital Corp., 2020 SCC 10 which describes the evolving nature of CCAA proceedings and the role of the judge supervising them. He emphasizes the purpose of the CCAA to save businesses as a going concern for the benefit of all stakeholders, and the privileged position of the supervising judge to evaluate and weigh the interests and objectives at stake. He also emphasizes the requirements that the parties act with good faith and diligence in the proceedings, and the power of the Court under section 11 CCAA to make any order that it considers appropriate in the circumstances subject only to the restrictions set out in the CCAA itself. He concludes that contemporary economic problems require innovative solutions which should be approved by the Court if they permit the objectives of the CCAA to be met for the benefit of all.
The judge relies heavily upon the testimony and report of the court-appointed Monitor to conclude that the company acted in good faith and with diligence, and that the proposed transaction and RVO is the best alternative available, offers benefits to the stakeholders and is appropriate in the circumstances.
The alternatives would be: i) Orion realizing on its security, after having been patient for many months; ii) suspending the business in order to attempt another SISP in several months at a great cost and in a market that has already been evaluated as highly uncertain and risky; or iii) bankruptcy, a catastrophic outcome for all, including Mr. Cantore, the employees, creditors, suppliers, the Cree Nation and the economy of the affected regions. The criteria required by section 36(3) CCAA have been met and the advantages of the proposed transaction are obvious, so the Court must exercise its discretion to approve the innovative and creative solution which has been put forward. The judge notes that Mr. Cantore said he would not contest the RVO if his own real rights claim were settled to his satisfaction, which shows the lack of legitimacy of Mr. Cantore’s arguments.
The judge nevertheless discusses, and dismissed, certain of Mr. Cantore’s argument specifically. He finds that section 36(1) CCAA provides authority to grant an RVO even though the RVO is not limited to a “sale or disposition of assets”. In the circumstances, an RVO permitted a better outcome for creditors by encouraging concessions from the sponsors that should allow a larger distribution to creditors. Furthermore, under section 36(6) CCAA an RVO may “purge” real rights (transfer the company to the purchasers free and clear of real rights or security on its remaining assets), otherwise holders of real rights would have a veto on such transactions.
The Court also holds that the proposed transaction and RVO are permissible even though they allow the company to emerge from CCAA protection outside the confines of a plan of arrangement. The Court must consider the global picture rather than seek the legal basis for each step in the transaction. The latter approach would severely limit the range of innovative solutions available to deal with increasingly complex commercial and social situations.
Creditors need not vote on an application under section 36 CCAA. Such orders are subject only to Court approval and section 36(6) CCAA contains its own list of criteria. This is not a plan of arrangement requiring a vote of creditors, which will occur at a later step (likely after the steps set out in the proposed transaction of the successful bidders have been completed). The Court also found that the proposed transaction complies with the SISP order, although it is a hybrid transaction. The Monitor and the company had the required latitude to consider appropriate offers, subject to Court approval. Such approval is not required to be obtained at each step of the SISP, and it is preferable in the circumstances that it be obtained at the stage of the transaction and RVO approval. The Court also finds no issue with the timing of when New ParentCo and ResidualCo are to enter CCAA protection.
Mr. Cantore and another shareholder had asked that consideration of the proposed release of directors and officers be postponed to the plan approval hearing. The judge refused to do so on the basis that the release was part of the proposed transaction negotiated with the sponsors and that the exception for claims excluded by section 5.1(2) CCAA protected the shareholders. Similarly, the judge found that the conditional transfer of the excluded assets and liabilities, including the agreement and royalty with Mr. Cantore, to New ParentCo was permitted as part of the overall transaction and that Mr. Cantore does not have a veto. The Court refused to second guess the commercial reasons the successful bidders had for excluding certain secured claims or real rights from their offer and including others. Mr. Cantore’s claim will be dealt with at a later step in any case, which protects his rights.
The Court concludes that it has no doubt that the proposed transaction is fair and reasonable and should be approved as quickly as possible. The Court witnessed the efforts of the parties to achieve the transaction, and after several months, it is the only offer on the table. To refuse it would be catastrophic.
The Court approved the transaction and RVO with costs, according to the draft submitted by the company. The Court considered it urgent to do so to avoid any further delays for the sponsors. Any additional delays would also cause prejudice to the company, its employees and suppliers, creditors, the Cree Nation (a significant stakeholder) and the regions affected. For these reasons, the RVO is made enforceable notwithstanding appeal (i.e., provisional execution was granted) and without the need for any security to be provided.
Approval of the first RVO in Canada after a contested hearing is an important step forward in the use of this innovative mechanism. The reasons for judgement of Gouin J. are a strong endorsement of the value of this new tool, which provides additional options for insolvent companies. Companies, purchasers and stakeholders alike stand to benefit considerably from this new flexibility.
1 The reverse vesting order and reasons for judgment were rendered on October 15, 2020 by Louis J. Gouin J. of the Superior Court of Quebec (Commercial Division) in file no. 500-11-057716-199. This decision is not final as of the writing of this bulletin, as the appeal period has not expired.
2 Torys acted for Orion.
3 This is a simplification of the multi-step transactions envisaged by the RVO as approved by the Court.
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