Mergers & Acquisitions in a More Uncertain World: Using the Companies Creditors Arrangement Act

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1 Mergers & Acquisitions in a More Uncertain World: Using the Companies Creditors Arrangement Act You are probably aware of the useful protective reconstruction provisions available to insolvent corporations in the United States under Chapter 11 of the United States Bankruptcy Code. In Canada, similarly useful statutory provisions are available to stakeholders in substantial insolvent Canadian corporations and those interested in acquiring such corporations or their assets. This statutory regime is under the Companies Creditors Arrangement Act, RSC 1985 c. C-35 (CCAA). Use of the CCAA can benefit both (i) insolvent corporations seeking to restructure themselves while protected from their creditors and (ii) buyers interested in obtaining the assets of distressed corporations on favourable terms and without some of the procedural hurdles imposed in other M&A transactions. In this article, we will tell you about the second of these two categories of benefits what the CCAA can do for M&A transactions. We will highlight those benefits and then briefly explain what the CCAA procedure involves. Key Benefits of the CCAA Broad Judicial Discretion Judges applying the CCAA process can use a broad discretion to allow insolvent corporations protection under the CCAA to deal with their assets. This broad discretion can allow for business combinations and asset sales to occur that might otherwise not be possible. Safe Haven for Directors of Distressed Corporations The directors of distressed corporations face profound business difficulties, which are compounded by the need to act speedily within a dense thicket of fiduciary and statutory duties. Central to these difficulties is the inability of the corporation to continue operations so as to realize or preserve the going concern value in the insolvent business that would likely be lost in a bankruptcy. If a distressed corporation s management is of the view that a sale of all or a part of the corporation s business is the best choice, this may not be possible in the available time or on terms acceptable to potential acquirors if unpaid creditors intervene or if shareholder approvals and regulatory or other third party consents are first required. The CCAA offers the management of troubled corporations a clear, judicially blessed (i) stay of creditor proceedings (ii) ability to continue operations, (iii) time to work out a fair and reasonable restructuring of the business, and/or (iv) time to arrange for a beneficial and expedited sale of assets or shares outside of bankruptcy.

2 Directors and officers still remain in control of the corporation during CCAA proceedings (albeit under the watchful eye of the court approved monitor) and thus must remain cognizant of their fiduciary and statutory duties. Management can legitimately ask for and receive protection going forward as an incentive to remain with the corporation during the process and CCAA orders often include indemnification for them. Safe Haven for Acquirers of Distressed Assets The purchaser of a distressed company or business can be equally challenging for a perspective investor or buyer. Investment in a faltering business may leave the investor ranking behind other creditors in a bankruptcy. Rights acquired in distressed assets may be judicially overturned as unfair to creditors. The CCAA offers judicially blessed benefits giving certainty and greatly reduced risk to those interested in purchasing distressed companies or their assets. Asset Sales under the CCAA In the normal course, the sale by a Canadian corporation of all or substantially all of its assets requires the approval of its shareholders by special resolution and may require other filings, approvals or consents (for example, those of stock exchanges, government authorities, joint venture partners or other contracting parties). The CCAA can facilitate obtaining such approvals or may obviate the need to obtain such approvals. An asset sale can occur during the CCAA process either as a means to finance a restructuring of the remaining assets of the debtor company or as the final creditor-approved outcome of the CCAA proceedings. While the courts prefer to see a sale of a business as a going concern, judges often approve CCAA asset sales in a more piecemeal fashion, even where that may have the effect of liquidating the debtor corporation. Liquidations under the CCAA are in fact quite common. The court will consider whether the proposed sale is fair and reasonable in the circumstances, giving consideration to the prejudice the decision may have to the stakeholders, but creditor approval of piecemeal sales is not necessarily required. In most Canadian provinces, the courts are prepared to approve sales of all or substantially all of the debtor corporation s assets outside of a creditor-approved plan of arrangement, although the courts in Alberta and British Columbia have, from time to time, had reservations about approving such sales. They have expressed the view that CCAA proceedings should be limited to restructuring, or if a sale is involved, approval of the sale by the creditors is necessary. These Alberta and British Columbia decisions do not, however, prevent parties from using the CCAA as a liquidating tool. The CCAA is remedial legislation, and the interpretation of it is dependent upon the facts of each case. There have been many cases in Alberta and in British Columbia in which the courts have permitted the sale of some or all of the assets of a corporation that is the subject of a CCAA restructuring without such sales forming part of a plan of arrangement. Page 2

3 The Canadian Parliament recently passed amendments to the CCAA. These amendments expressly permit the restructuring corporation to make application to court to permit it to dispose of assets outside of the ordinary course of its business. It is expected that the amendments will be in force by late January or early February 2009 (although with the current distractions occurring on Parliament Hill, it may likely be later). Share Sales under the CCAA An alternative to the sale of the assets of a restructuring corporation is a plan of arrangement involving an exchange of shares. Shares in the restructuring corporation can be obtained in exchange for shares in a solvent acquiring corporation. Such exchange is usually at a high ratio of exchange, such as 10 shares in the restructuring corporation in exchange for one share in the acquiring corporation. Shares in the acquiring corporation can also be distributed to the debtor corporation s creditors. The value provided to the corporation s creditors must be an improvement over the recovery that the creditors could reasonably have achieved through the exercise of their legal rights, such as the appointment of a receiver and the liquidation of the corporation s assets or a bankruptcy. The offer to purchase shares may include some level of cash consideration in order to obtain the requisite approval from unsecured creditors. Approval from the debtor corporation s shareholders is not required merely approval from the corporation s creditors. Where an acquiror wishes to secure control of a distressed target, there may be instances where CCAA proceedings are not feasible. For example, a great number of Canadian public resource companies are headquartered in Canada but have the bulk of their operations in foreign jurisdictions. CCAA proceedings in Canada may not safeguard the company s operations in the foreign jurisdiction, where obtaining equivalent protection will either be impossible or very time-consuming. Where a public issuer requires urgent financing, it can undertake a sizeable private placement that gives an acquiror control of the company while avoiding the usual shareholder approval the TSX normally mandates for significant dilutive financings, on the grounds of financial hardship. Stalking Horse Bids The CCAA regime allows the purchase of assets by what is known as a stalking horse bid. This approach is well-known in the United States, but relatively new in Canada. In this process, the restructuring corporation enters into an agreement with a potential bidder, the stalking horse bidder, for the sale of particular assets or the entire distressed business. An auction or tendering process is then undertaken to obtain the best offer possible. The stalking horse bidder, by virtue of having placed an arms-length value on the relevant assets through its due diligence, provides a price that underpins the auction process. The stalking horse bidder enters the process knowing it may lose out to a higher bidder and thus negotiates compensation for its transaction costs, usually in the form of a break fee that it will receive in the event its bid is not successful. The stalking horse bidder resembles the white knight in a takeover situation in that the break fee must be large enough to justify making the bid but small enough not to unduly inhibit the auction process. Page 3

4 Debtor in Possession Financing (DIP) DIP financing is the provision of new or additional financing to a restructuring corporation in the context of CCAA protection. Typically, a DIP loan is a secured revolving credit facility. It affords another means by which an investor can gain access to opportunities that might not otherwise be available by conventional methods. The practice of DIP financing began recently through the exercise of the broad discretion given to the courts under the CCAA. It first appeared as an outgrowth of court-ordered prioritized charges granted to Lenders in order to ensure payment of the administrative expenses of the restructuring corporation. Such orders were initially controversial, and some judicial decisions have suggested that if granted at all they should be kept to a bare minimum: only enough to keep the lights on at the restructuring business. The courts more recently have become more willing to grant prioritized DIP financing. Their jurisdiction to do so will become express through the amendments to the CCAA discussed above as soon as those amendments are proclaimed into force. The amended CCAA will allow the restructuring corporation to apply for an order to permit a lender to lend new money during a restructuring, potentially on the strength of a so-called primed charge that typically ranks ahead. The amendments to the CCAA offer general guidance by setting out the various considerations to be weighed when comparing the advantages of DIP financing with the potential prejudice to other creditors, particularly the potential erosion of their secured positions through the priming of a DIP loan facility. DIP lending may be attractive to investors for a variety of reasons. If the lender is interested in ultimately acquiring some or all of the debtor s business, providing DIP financing can give the lender a significant and sometimes a pre-eminent role in the management of the restructuring corporation (through covenants in the DIP financing documents) and the course of the restructuring proceedings (as a senior secured creditor). This may be a critical advantage in positioning an investor for an acquisition. Even if the target assets are not purchased, DIP financing can be profitable by virtue of the attractive spread that is often available in such distressed situations, with the risk moderated by a primed charge. The Acid Bath of the Vesting Order When assets are sold through CCAA proceedings, whether as part of the financing of a restructuring or through a creditor and court-approved overall plan of arrangement, a vesting order is issued by the court. The effect of the vesting order is that the creditors claims to the assets included in the sale are converted into claims to the proceeds of the sale, with the creditors ranking in their pre-vesting order priorities in respect of the distribution of such proceeds. Registered encumbrances, security interests and claims against the assets are terminated so that the assets are completely cleaned of third party interests by the vesting order. Page 4

5 The vesting order also can remove the need to obtain certain consents and other requirements for closing a transaction contemplated in a successful CCAA plan of arrangement. This would include shareholder consent and consents from parties to contracts concerning the assets. In addition, certain regulatory requirements under securities and other legislation can be avoided or ameliorated through the vesting order. The vesting order offers purchasers a means to obtain assets free of encumbrances without the need to obtain various third party consents. How the CCAA Regime Works Initial Application to Court To qualify to use the CCAA, a corporation must be insolvent and have outstanding liabilities of $5 million or more. To initiate CCAA proceedings, the insolvent corporation must make an application to court for an order imposing a stay of proceedings upon creditors and authorizing the corporation to prepare a plan of arrangement to compromise its indebtedness with some or all of its creditors. The plan of arrangement should propose fair and reasonable returns for all of the corporation s stakeholders, including its creditors, shareholders, and employees. In support of such application, an affidavit is prepared by the corporation that describes its background, financial difficulties and the reasons it is seeking CCAA protection. Usually, the initial order is made in the form of a draft order prepared by the corporation and appended to the application and affidavit as one of the application documents, with little to no input from creditors and other stakeholders. Affected parties (including creditors) may apply to court to vary the initial order after it is made. Generally, an initial order does the following: (a) (b) (c) (d) (e) authorizes the corporation to prepare a plan of arrangement to put to its creditors; authorizes the corporation to stay in possession of its assets and to carry on business in a manner consistent with the preservation of its assets and business; prohibits the corporation from making payments in respect of past debts (other than specific exceptions, such as amounts owing to employees) and imposes a stay of proceedings (i) preventing creditors and suppliers from taking action in respect of debts and payables owing as at the filing date, and (ii) prohibiting the termination of contracts by parties doing business with the corporation; authorizes the corporation, if necessary, to obtain additional financing (such as debtor in possession financings as discussed above) to ensure that it can fund its operation during the proceedings, including setting limits on the aggregate funding and the priority of the security; and authorizes the corporation to terminate unfavourable contracts, leases and other arrangements, to shut down facilities, and to make provision for the consequences (for example, damage claims) in the plan of arrangement. Page 5

6 The CCAA legislation itself provides that an initial order may only impose a stay of proceedings for a period not exceeding 30 days. The restructuring corporation, however, can and often does apply for a further order or orders extending the stay of proceedings. Such extensions are generally obtained to permit the stay to continue while the corporation s plan of arrangement is presented to creditors and approved by the court. The duration of proceedings under the CCAA usually is from 6 to 18 months but can be completed in much less time. The Fair and Reasonable Test When considering whether to approve a plan of arrangement, the court will consider whether the plan fairly balances the interest of all of the debtor corporation s creditors, shareholders and employees and whether the plan represents a fair and reasonable compromise that will permit a viable commercial entity to emerge. The court will also consider factors such as: (i) whether the proposed plan brings more value to creditors than a bankruptcy or liquidation alternative, (ii) whether there has been any oppressive conduct towards creditors, (iii) whether there is the retention of jobs, and (iv) the public interest, in a successful workout strategy. In deciding whether to grant the vesting order, the court will also look at the degree of approval of the plan by the debtor corporation s creditors, noting that the parties involved are generally the best judge of their own interests. The court will generally favour a plan that has received strong support from creditors. Creditor Approval For a plan of arrangement to be approved by creditors, a majority of the creditors representing twothirds in value of the claims of each class or creditors, present and voting (either in person or by proxy) at the meeting or meetings of creditors, must vote in favour of the plan of arrangement. Considering that such approval is required, and that the CCAA does not contain formal cram down provisions, the determination of a class of creditors is a key issue in CCAA proceedings. The courts have generally applied a commonality of interest test in defining creditor classes. Aligning the interests and grouping the creditors together properly is often crucial to obtaining creditor approval. In a focused and efficient plan, the right balance needs to be struck between sharing the pain of compromise among creditors fairly, and minimizing complexity, cost and delay. Conclusion By taking the time to understand the CCAA regime, those looking to obtain the assets of distressed companies can do so relatively quickly and economically. Not only can assets be successfully acquired on good terms, but reasonable, relatively risk-free returns can be obtained by those willing to provide DIP financing to insolvent companies. Significant changes in the economy call for significant changes in business dealings. The CCAA regime will be an important tool in many transactions resulting from the current economic decline. Authors: Sean Collins, Dean Hutchison, Warren Milman and Roger Taplin ~ December, 2008 Page 6

7 For more information, please contact: VANCOUVER Warren B. Milman CALGARY Sean F. Collins TORONTO James D. Gage OTTAWA Thomas G. Conway MONTRÉAL Sylvain A. Vauclair