Houlden & Morawetz On-Line Newsletter

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1 Houlden & Morawetz On-Line Newsletter Date: February 20, 2012 Headlines The Ontario Superior Court of Justice granted a receivership order and dismissed the debtors cross application for an initial order under the CCAA. There had been ongoing default by the debtors in respect of their obligations to the secured creditors and the debtors were unable to present even a germ of a plan. See Case Updates [Callidus Capital Corp. v. Carcap Inc.]. The Ontario Superior Court of Justice approved a sale of assets by a receiver to a party related to the debtor. In such circumstances, the court emphasized that it is incumbent on the receiver to review and report on the activities of the debtor. It is not sufficient to accept information provided by the debtor, where a related party is purchaser, without taking steps to verify the information. See Case Updates [Toronto Dominion Bank v. Canadian Starter Drives Inc.]. The Registrar of the Nova Scotia Supreme Court held that proceedings to determine whether certain EI benefits improperly paid should be returned were proceedings stayed by the recipient s bankruptcy. However, in the circumstances, it was appropriate to lift the stay nunc pro tunc. See Case Updates [Re Coyle]. Case Updates [Callidus Capital Corp. v. Carcap Inc.] Callidus Capital Corp. v. Carcap Inc. (2012), 2012 CarswellOnt 480, 2012 ONSC 163 (Ont. S.C.J. [Commercial List]) Callidus Capital Corp. ( Callidus ) brought an application for the appointment of a receiver of CarCap Inc. and Car Equity Loans Corp (the Debtors ). The Debtors brought a cross application for an initial order under the Companies Creditors Arrangement Act ( CCAA ). Justice Mesbur dismissed the Debtors cross application and appointed a receiver. Callidus was the first secured lender of the Debtors. It sought the appointment of a receiver under both the Bankruptcy and Insolvency Act ( BIA ) and the Courts of Justice Act ( CJA ). TD Bank, the second secured lender, supported the receivership application, pointing out that none of the Debtors refinancing proposals included sufficient financing to retire the debt due to TD Bank. Both Callidus and TD Bank opposed the relief requested by the Debtors under the CCAA. CarCap Inc. ( Car ) was in the business of sub-prime car lease financing. Another responding party, Cashland, provided sub-prime equity car loans. Both companies were subsidiaries of CarCap Auto Finance Inc., which itself is a subsidiary of Kaptor Financial Inc. Kaptor Financial owned several other companies, in whole or in part. The parties referred to these companies as the Kaptor Group. Mr. Eric Inspektor controlled the entire Kaptor Group, either directly or indirectly. On September 1, 2011, Callidus replaced Laurentian Bank as the Debtors first secured lender. Under the credit agreement, it agreed to advance a demand loan of up to $15 million subject to certain margin conditions. As a term of the agreement, the Debtors were required to establish blocked accounts at a bank. The Debtors had to deposit all funds they received from all sources into these block accounts. The respondents established the blocked accounts at TD Bank. The Debtors were also required to disclose details of all debts outstanding. The Debtors did not disclose they owed money to TD Bank, although at the time they did. The credit facility with Callidus provided that it was due on demand, and was repayable in full on the earlier of September 1, 2012 or an event of default. Remedies on default included the right to appoint a receiver and to apply to court to appoint a receiver.

2 The Debtors and other Kaptor Group companies initially had only deposit accounts with TD Bank. In July and August of 2011, TD Bank noticed what it characterized as a high rate of unusual activity in the Debtors accounts as well as in those of other Kaptor Group companies. Ultimately, TD Bank froze the Kaptor Group accounts when they were in an overdraft position of $7 million. TD Bank entered into an accommodation agreement with the Kaptor Group, including the Debtors. The accomodation agreement, dated August 23, 2011, provided a secured loan of $5 million to cover the overdraft and provided working capital. The loan was to be repaid by August 29, It was not. Callidus knew nothing about the Kaptor Group s/debtors overdraft with TD Bank, the accommodation agreement or the failure to repay the TD loan. On September 1, 2011, Callidus made its first advance into the Debtors disbursement accounts. Mesbur J. noted that given the Debtors situation with TD Bank at the time of the advance, the Debtors were in breach of their representations to Callidus in the credit facility agreement. TD Bank s accommodation agreement was further amended and ultimately terminated by agreement on September 16, The Debtors owed TD Bank at the time about $1 million. Before TD Bank made its various accommodation agreements with the Debtors and the Kaptor Group, there was a three week period in September where TD Bank returned as NSF many cheques the Debtors had written for payroll, investor payments and dealer and supplier payments. Callidus did not learn of any of the Debtors agreements with TD Bank, or the security they had given TD Bank until three weeks after Callidus had made its first advance. Matters deteriorated and TD Bank dishonoured various Cashland cheques. Dealers were complaining to the Ontario Motor Vehicle Industry Council. Callidus ultimately conducted a field audit and discovered that some government remittances were made late. Callidus took the position that the respondents had made misrepresentations and material non-disclosure. It was not prepared to continue to lend. On October 18, 2011, it demanded payment in full, pursuant to the terms of the credit facility agreement. Callidus also served notice under section 244 of the BIA of its intention to enforce its security. On October 25, 2011 Callidus entered into a forbearance agreement with the Debtors. In the agreement, the Debtors waived the 10 day notice and consented to the immediate enforcement of Callidus security. The forbearance agreement also required the Debtors to hire a new interim executive officer and they hired MNP Corporate Finance Inc. to find them alternative financing so they could pay out Callidus by April 30, The Debtors were not able to secure alternate financing. The agreement also required the Debtors to submit a complete restructuring plan to Callidus by November 30, The plan had to be acceptable to Callidus and had to be completed by December 31, The Debtors were unable to comply with either of these conditions. Justice Mesbur noted that although the parties conceded the term was not enforceable, the forbearance agreement also contained a promise from the Debtors not to commence any restructuring or reorganization proceedings under the BIA or CCAA. Since the forbearance agreement, Callidus submitted that the Debtors financial position had deteriorated further. The loan balance had increased by more than $770,000 while the lease rental stream had dropped by about $225,000. By the end of November, the Debtors were in an over advance position of more than $1.2 million. On November 24, 2011, Callidus terminated the forbearance agreement and advised the Debtors it would apply to court to have a receiver appointed. In argument, Callidus took the position that the Debtors had made material misrepresentations even before the first advance. It said that had it known of the Debtors situation with TD Bank it would never have agreed to advance in the first place. The financial position of the Debtors had since deteriorated and the demand for payment had not been satisfied. The

3 revenue stream was declining, meaning the Debtors could not acquire new vehicles to lease. This resulted in a reduction of its security and increasing debt. As a result, Callidus submitted it was both just and convenient to appoint a receiver in order to protect its security and the interests of other stakeholders. The Debtors accused Callidus of taking an aggressive and unreasonable position. They pointed out that they were not actually behind in their payments. They suggested that if they were able to have a CCAA stay in place for 13 weeks, they would be able to restructure. Mesbur J. noted, however, that they did not present any restructuring plan, even in very draft form. In order to answer the question as to whether a receiver should be appointed, Mesbur J. noted that the court must consider all the circumstances of the case, particularly: a) The effect on the parties of appointing the receiver. This includes potential costs and the likelihood of maximizing return on and preserving the subject property; b) The parties conduct; and c) The nature of the property and the rights and interests of all parties in relation to it. Mesbur J. referenced Bank of Nova Scotia v. Freure Village on Clair Creek (1996), 1996 CarswellOnt 2328, 40 C.B.R. (3d) 274 (Ont. Gen. Div. [Commercial List]), and Bank of Montreal v. Carnival National Leasing Ltd. (2011), 74 C.B.R. (5th) 300, 2011 ONSC 1007, 2011 CarswellOnt 896 (Ont. S.C.J.). Further, Mesbur J. noted that many security agreements specifically contemplate appointing a receiver. The fact that the creditor has a right to appoint a receiver under its security is therefore an important consideration. Generally, she noted, a court will appoint a receiver when it is necessary to enforce rights between the parties or to preserve assets pending judgment. Receivers will also be appointed where there is a serious apprehension about the safety of the assets. In this case, the credit agreement itself specifically contemplated appointing a receiver. Following the reasoning in Fruere Village, Mesbur J. noted that the extraordinary nature of the remedy was therefore less important here than it might otherwise be. Justice Mesbur then commented on the likely effect on the parties of appointing a receiver. From Callidus point of view, it would allow it to protect its security and to dispose of it in an organized and court supervised fashion. Callidus proposed to sell the businesses as a going concern. The Debtors conceded that a possible restructuring plan might be to liquidate, in which case the hope would also be a going concern sale. In this regard, Mesbur J. saw no difference in outcome if a receiver was appointed. Justice Mesbur also referenced that the Debtors difficulties with the TD Bank overdraft arose in August 2011 and they had been given every opportunity since then to cure their default but had failed to do so. Similarly, the Debtors had been in default with Callidus since it demanded payment in October 2011 and even though Callidus had agreed to forebear, the Debtors had failed to honour the terms of the forbearance agreement. Mesbur J. also noted that neither Callidus nor TD Bank had faith in the Debtors management As to the nature of the property, MesburJ. noted that Callidus security was declining in value. Both secured creditors rights in it were being eroded. Consequently, she concluded that the court must put an end to the continued haemorrhaging of money. Given the Debtors failure to come up with even a rudimentary restructuring plan, she found that it was time for a receiver to take control and manage the business to the extent necessary to result in an orderly liquidation to protect the interests of all stakeholders. With respect to the CCAA application, Mesbur J. noted that the Debtors had no operating capital. They were in default, with two unwilling lenders who were not prepared to lend more. Under the CCAA these lenders had no obligation to advance more funds. Without further advances, the Debtors could not continue to operate without further deterioration in inventory of vehicles and the resulting deterioration in revenue.

4 The Debtors had asked what the harm was in letting them reorganize. Mesbur J. noted that while that was an interesting question, it was not the test. She was of the view that the position put forth by the Debtors was nothing more than a last ditch effort on the Debtors part to stave off the inevitable. The Debtors only brought their application after Callidus had brought its application for a receiver. As a result, the cross application for CCAA relief seemed more of a defensive tactic that a bona fide attempt to restructure. The Debtors had no restructuring plan, they had no outline of a plan and they did not even have a germ of a plan. In such circumstances, Mesbur J. saw no merit in making an initial order and imposing a stay in circumstances where plan of arrangement was most likely going to be defeated. In this respect, she referenced Re Marine Drive Properties Ltd. (2009), 2009 CarswellBC 285, 2009 BCSC 145, 52 C.B.R. (5th) 47 (B.C. S.C.), and Re Inducon Development Corp. (1991), 1991 CarswellOnt 219, 8 C.B.R. (3d) 306 (Ont. Gen. Div.). In the result, Mesbur J. declined to grant relief under the CCAA and appointed a receiver. See Houlden & Morawetz, Bankruptcy and Insolvency Law of Canada: L 3 Appointment of Receiver and Manager N 63 Stay of Proceedings, Generally N 64 Procedure for Obtaining a Stay Order [Toronto Dominion Bank v. Canadian Starter Drives Inc.] Toronto Dominion Bank v. Canadian Starter Drives Inc. (2011), 2011 ONSC 8004, 2011 CarswellOnt (Ont. S.C.J. [Commercial List]) The court-appointed receiver (the Receiver ) of Canadian Starter Drives Inc. ( Starter ) brought a motion to approve a sale and for the granting of a vesting order. The motion was originally returnable on December 5, It did not proceed at that time and periodic adjournments were granted and the matter was heard on December 8, Justice Morawetz noted that the circumstances surrounding the motion were somewhat unusual. The proposed purchaser was related to the debtor. The landlord was related to the debtor. The consideration arising from the proposed sale provided an acceptable recovery to the secured creditor, TD Bank but no recovery for subordinate creditors. Justice Morawetz also observed that the Receiver, in conducting a sales process, was expected to follow the Soundair principles. The process should be transparent and should enable the court to make an informed decision as to whether the sale could be considered fair and reasonable in the circumstances. He was not satisfied that the First Report of the Receiver provided sufficient detail to allow him to make an informed decision. The circumstances involving a related party as landlord and a directly related party as purchaser, required the Receiver to provide sufficient detail in order to satisfy the court that the best result was being achieved. It was incumbent upon a court-appointed receiver to review and report on the activities of the debtor. It was not sufficient to accept information provided by the debtor where a related party is purchaser without taking steps to verify the information. The Receiver provided a Supplemental Report which addressed the above referenced concerns. Justice Morawetz observed that a court receivership process had been undertaken by the Applicant. Generally speaking, a sale approval order, if granted, provides a degree of comfort to a receiver and other parties that the court has considered the issues and has concluded that circumstances are such that the sale can be said to be fair and reasonable. If a receiver seeks such an outcome, sufficient evidence has to be put before the court. This was done in the Supplemental Report and Morawetz J. was satisfied that the sale was reasonable in the circumstances and it was approved. See Houlden & Morawetz, Bankruptcy and Insolvency Law of Canada: L 18 Duties and Powers of the Receiver

5 L 20 Sale of Assets by a Receiver and Manager [Re Coyle] Re Coyle (2011), 2011 NSSC 469, 2011 CarswellNS 904 (N.S. S.C.) Registrar Cregan observed that this application first came before him on March 15, At that time, counsel for the Office of the Superintendent of Bankruptcy ( OSB ) raised an additional issue which the other parties were not prepared to address. The application proceeded on the understanding that Registrar Cregan would hear the parties on the additional issue once he released his decision on the original application. The original application is cited as Re Coyle (2011), 2011 CarswellNS 415, 2011 NSSC 238, (sub nom. Re Coyle (Bankrupt) v.) 960 A.P.R. 369, (sub nom. Re Coyle (Bankrupt) v.) 304 N.S.R. (2d) 369 (N.S. S.C.). The Applicant, Ms. Coyle, made three separate claims for benefits under the Employment Insurance Act ( EI Act ). Benefits were paid to her. The Canada Employment Insurance Commission ( Commission ) in processing these claims determined that she had made fraudulent misrepresentations and the benefits should not have been paid. The Commission sought to recover the benefits using the procedures in the EI Act. She appealed this determination to the Board of Referees ( Board ) established under the EI Act and made an assignment in bankruptcy on January 31, The Board heard her appeals, one on February 5, 2008 and the other two on December 17, It confirmed that the Commission was entitled to recover these payments from her. The original issue was whether the Board was competent to determine whether the obligation to reimburse the Commission would be discharged upon her discharge from bankruptcy on March 25, 2009 or would survive bankruptcy, being debts of the kind described in subsection 178(1)(e) of the Bankruptcy and Insolvency Act ( BIA ). In his first decision, Registrar Cregan found that the Board had the authority to determine whether such debts fell under the aforementioned provision of the BIA. The additional issue was simply whether the proceedings before the Board were subject to the stay directed by subsection 69.3(1) of the BIA. Registrar Cregan also noted that subsection 69(4) of the BIA permits the court to lift the stay, but such relief was not sought. Registrar Cregan had to first determine whether the proceedings before the Board were subject to the stay and if so, whether the stay could now be lifted nunc pro tunc. Subsection 69.3(1) of the BIA reads: Subject to subsections (1.1) and (2) and section 69.4 and 69.5, on the bankruptcy of any debtor, no creditor has any remedy against the debtor or the debtor s property, or shall commence or continue any action, execution or other proceedings, for the recovery of a claim provable in bankruptcy. Counsel for the Commission submitted that subsection 69.3(1) did not apply to proceedings before the Board as they were not commenced by the Commission which was the creditor, but by the Applicant who was the debtor. Counsel to Ms. Coyle submitted that the proceedings before the Board were part of the enforcement process provided to the Commission in the EI Act for the collection of money alleged to be recoverable by it. Thus, the stay should apply. Counsel for the OSB noted that appeals before the Board are not true appeals, but rather trials de novo. The proceedings before the Board are the first opportunity for a claimant to make submissions before an impartial tribunal. Simply put, the hearing before the Board is the first judicial proceeding involving both the Applicant and the Commission. A number of cases were cited to Registrar Cregan respecting the reasons for the stay provision. He referenced R. v. Fitzgibbon (1990), [1990] 1 S.C.R. 1005, 107 N.R. 281, 40 O.A.C.

6 81, 78 C.B.R. (N.S.) 193, 55 C.C.C. (3d) 449, 76 C.R. (3d) 378, 1990 CarswellOnt 172, 1990 CarswellOnt 996 (S.C.C.), where Cory J. stated at page 1015:... The object of the section is to avoid a multiplicity of proceedings and to prevent any single unsecured creditor from obtaining a priority over other unsecured creditors by bringing an action and executing a judgment against the debtor. This is accomplished by providing that no remedy or action may be taken against a bankrupt without leave of the court in bankruptcy, and then only upon such terms as the court may impose. Registrar Cregan reviewed the nature of the proceeding. He noted that it was not the appeal of a judicial decision but rather was a procedure whereby the Commission must from the start prove its claim before the Board, it being a judicial body empowered by the EI Act to determine the validity of the Commission s claim. Either party may appeal to the next judicial level, the Umpire and further to the Federal Courts and ultimately the Supreme Court of Canada. Registrar Cregan stated that the narrow question was one of who was asserting the claim. It is the one who was being stayed. In this case it was the Commission. The Applicant was simply asserting her right to have the claim against her judicially determined. The burden remained on the Commission. The right to defend or the action of defending a claim was not stayed. What was stayed was the proceeding whereby a claim was asserted or pursued. Registrar Cregan was of the view that what was important was not the use of the word appeal in the EI Act, rather what was the substance of the proceedings. Registrar Cregan was also the view that although the proceeding was described as an appeal by the Applicant, it was really a trial or hearing of first instance with the Commission seeking to prove its claim against the bankrupt. Further, as fraud was alleged by the Commission and found by the Board, the burden of proof clearly was on the Commission. Notwithstanding that the Applicant was referred to as the Appellant, the moving party was in substance the Commission. It was the Commission that was seeking relief, i.e. confirmation of its administrative decision. Registrar Cregan concluded that this was a situation intended to be stayed by subsection 69(3). This was not done. The proceedings were therefore irregular. The Commission could only revive its claim by obtaining a lifting of the stay nunc pro tunc or by trying to reinstate or repeat proceedings before the Board. Registrar Cregan expressed no opinion as to whether the latter was now possible. Registrar Cregan then analyzed the issue of lifting the stay under subsection 69.4 nunc pro tunc. He noted that it is well established that the failure to have the stay lifted before proceedings is only an irregularity. Leave to proceed or lifting of the stay, whichever way one wishes to describe it, can be granted nunc pro tunc. (See Trusts & Guarantee Co. v. Brenner (1932), [1932] O.R. 245, 13 C.B.R. 518, [1932] 2 D.L.R. 688, 1932 CarswellOnt 28 (Ont. C.A.).) A lifting of the stay can be granted if the court is satisfied that the creditor is likely to be materially prejudiced by the operation of the stay or it is equitable on other grounds to lift the stay. He referenced Re Kandasamy (2009), 2009 CarswellOnt 956, 50 C.B.R. (5th) 207 (Ont. S.C.J.); Re Advocate Mines Ltd. (1984), 52 C.B.R. (N.S.) 277, 1984 CarswellOnt 156 (Ont. S.C.); and Re Ma (2001), 143 O.A.C. 52, 2001 CarswellOnt 1019, 24 C.B.R. (4th) 68 (Ont. C.A.), which held that it was not necessary to prove a prima facie case to have a stay lifted. What are required are simply sound reasons consistent with the scheme of the BIA. In this case the prejudice for the Commission was that it would be denied the right of remedy against the Applicant when it had reasonable bases for asserting a claim framed in fraudulent misrepresentation, which, if proved, would survive bankruptcy. This was how it was likely to be materially prejudiced. No submissions were made that the administration of the estate would have been prejudiced, if the stay were lifted. Registrar Cregan was satisfied that the stay would have been lifted, if it had been sought before the commencement of proceedings before the Board. Further, if the stay was not now granted nunc pro tunc, the Commission may not be able to reassert its claim and will have lost the benefit of the determination of the Board. The Applicant on the other hand might be

7 relieved of debts for technical reasons, notwithstanding their validity as debts which survive bankruptcy which was confirmed by the Board and in this application. Having considered the issue, Registrar Cregan noted that the overriding theme in the commentary and case law strongly suggested that where debts fraudulent in character and surviving bankruptcy were in issue, not only should stays be lifted, if sought at the appropriate time, but also if sought nunc pro tunc. Otherwise, the integrity of the bankruptcy system would be prejudiced. In the result, Registrar Cregan exercised his discretion by granting a lifting of the stay nunc pro tunc. See Houlden & Morawetz, Bankruptcy and Insolvency Law of Canada: F 114 Stay of Proceedings: Unsecured Creditors F 117 Granting of Leave Nunc Pro Tunc F 163 Lifting the Stay