With the recent flurry of reverse vesting orders (RVOs) in Canadian insolvency proceedings in the last two years, courts have warned against over-use of this distressed M&A structure. In PaySlate Inc. (Re), 2023 BCSC 608, the Supreme Court of British Columbia hit reverse. The Court, in reinforcing the judicial view of RVOs as an extraordinary remedy rather than a new norm, refused to grant an RVO and its related releases and claims bar, and provided further guidance as to the circumstances when a court should, and should not, grant an RVO.
This case illustrates circumstances in which a court will refuse to grant an RVO.
PaySlate Inc. is a technology company that provides online property rental payment processing services, primarily to owners and managers of real property. Its assets are comprised almost entirely of “soft” assets—customer service agreements, intellectual property, its workforce and certain tax attributes consisting of tax credits and scientific research and experimental development tax credits. Due to financial distress, PaySlate filed a notice of intention to make a proposal to its creditors under the BIA in December 2022.
Following an unsuccessful court-approved sale and investment solicitation process (SISP), PaySlate entered into a share purchase agreement with its debtor-in-possession lender (the Purchaser), under which the Purchaser would acquire all of PaySlate’s shares through an RVO transaction. Importantly, the Purchaser was an insider that shared the same key principal as PaySlate.
PaySlate’s RVO transaction was opposed by one of PaySlate’s unsecured critical suppliers, which argued, among other things, that PaySlate had failed to give appropriate notice to its creditors, establish that the RVO was necessary to continue its business as a going concern and prove that there was no viable alternative to the RVO transaction that might leave stakeholders better off.
The key issue was whether the proposed RVO transaction met the requirements for court approval.
The Court refused to grant the RVO.
The Court echoed the judicial view that RVOs are not the norm and should be granted only in extraordinary circumstances. Building on recent RVO decisions such as Harte Gold, Quest University Canada and Just Energy Group Inc., the Court recognized that heightened scrutiny and diligence must be applied to RVOs because they lack many of the key statutory safeguards that normally provide economic stakeholders with a “voice” in the debtor’s restructuring. For example, a proposal under the BIA or a plan of arrangement under the CCAA both give unsecured creditors their voice by entitling them to vote on the debtor’s proposed path forward; RVOs do not. While RVOs are appropriate in limited circumstances, such as for preserving non-transferrable assets like licenses, intellectual property and tax attributes, they are not a one-size-fits-all solution.
Accordingly, in addition to the guidance provided by those recent decisions and the factors set out in section 36(3) of the CCAA (and the analogous Soundair factors), the Court added that:
With these factors in mind, the Court held that PaySlate had failed to establish that the RVO transaction met the requirements for approval.
First, PaySlate had failed to serve notice of its RVO transaction on the contractual counterparties whose rights would be impaired. Those counterparties would have been required to carry on providing services to PaySlate, but with restricted contractual rights, a broad release of their pre-filing claims against PaySlate and certain third parties (other than cure costs channeled to a residualco-style creditor trust) and a risk of not being fully paid for post-closing services by a troubled debtor. The Court rejected PaySlate’s arguments that service would be unduly burdensome, given particularly that PaySlate intended to provide notice to those counterparties after the retention of their contracts had been approved anyway.
Second, the Court was not satisfied that the RVO transaction was truly meant to preserve PaySlate’s business as a going concern. This issue primarily arose from what the Court viewed as an incompatible position. On the one hand, PaySlate submitted that, being a business with minimal “hard” assets, its employees were a critical component of its value and ability to operate as a going concern. On the other hand, PaySlate intended to terminate half of its workforce in connection with the transaction. The Court thus found PaySlate’s and the Purchaser’s evidence regarding the purpose of the RVO problematic.
Finally, the evidence submitted by PaySlate and the Proposal Trustee regarding the value of PaySlate’s tax attributes—some of its largest assets—was not fulsome enough to determine that there was no viable alternative to the RVO transaction that might leave stakeholders better off. While the Proposal Trustee had filed a supplemental report shortly before the hearing, the report did not identify the sources for much of the valuation information, nor did it provide the qualifications or expertise of its author. While not every case involving an RVO may require expert valuation opinions, at a minimum, robust evidence concerning the value of the assets, including its tax attributes, should have been provided well before the hearing began. Here, the value could also not be inferred based on what the Purchaser was willing to pay for it, even though there were no successful bids following the SISP.
The Court’s guidance in PaySlate illustrates that RVOs do, indeed, have their limits. Given the emerging widespread judicial view that RVOs are an extraordinary measure, parties seeking approval of their RVO structure, and any accompanying releases, should be vigilant in ensuring procedural fairness (including proper notice) and preparing a strong evidentiary record that establishes the RVO as a necessary means to achieve a proper, compelling purpose.
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