A Paper Prepared for a CALL/CAMS 2004 Conference

“Companies’ Creditors Arrangement Act”

June 3-6, 2004

Prepared by Ken Rosenberg/Marcus Knapp
Paliare Roland Rosenberg Rothstein LLP
Toronto
Companies’ Creditors Arrangement Act (“CCAA”)

This paper provides a general summary of the CCAA and the manner in which restructurings are carried out under it.

1. Scope of the Proceedings under the CCAA

The CCAA is one of two federal statutes in Canada under which insolvent corporations enter into Court sanctioned arrangements with their creditors as an alternative to bankruptcy, winding-up or liquidation.^[1] While the CCAA is similar in many respects to Chapter 11 of the United States Bankruptcy Code, it is drafted in an extremely general manner, leaving a great deal to the discretion of the Courts. The CCAA allows a corporate debtor, under court supervision, to prevent creditors or other parties from enforcing remedies against the debtor during the court proceedings so that the debtor can attempt to settle or rearrange its liabilities. Liabilities which can be compromised include claims of secured creditors, unsecured creditors and federal and provincial governments (other than for withholdings under the Income Tax Act (Canada), Canada Pension Plan (Canada) and Employment Insurance Act (Canada) and similar provincial legislation). In certain circumstances, the CCAA also allows the debtor to compromise claims of creditors against its directors where such claims relate to obligations of the debtor.

2. Commencement of the Proceedings and the Initial Order

Under the CCAA, an insolvent corporate debtor and/or its affiliates may commence a proceeding with the Court for protection from its creditors. In order for a debtor to qualify for protection, the total of claims against it must exceed Cdn. $5 million. Provided that the debtor qualifies for protection under the CCAA, the Court will make an initial order (the “Initial Order”) which recognizes the right of the debtor to seek relief under the CCAA and which will or may provide (because it is in the discretion of the Court) for the following:

(a) Stay of Proceedings - All proceedings against the debtor by creditors or parties to contracts with the debtor will be stayed. The stay of proceedings prevents creditors or persons with contractual relations with the debtor (other than parties to certain hedging agreements) from commencing or prosecuting any actions against the debtor or exercising any judicial or extra-judicial remedies against it without leave of the Court. The stay order is for an initial period of 30 days, which can be extended upon application of the debtor. The debtor must satisfy the Court that such an extension is appropriate and that it is acting in good faith and with due diligence. Usually, the Court will extend the stay for consecutive periods of three or four months. At each motion for an extension, the debtor must satisfy the Court that a further one should be granted. The Court may lift the stay against specific creditors or third parties where they can demonstrate that they will suffer prejudice as a result of the stay which substantially exceeds the prejudice suffered by the debtor as a result of the lifting of the stay. Courts, however, are reluctant to grant such partial releases of stay orders and thus the person moving for such an order bears a heavy onus.

(b) The Monitor - The Court will appoint a court officer referred to as a Monitor (which is generally the work out/insolvency affiliate of an accounting firm, and is often the debtor’s auditor) to monitor the business and financial affairs of the debtor while the order remains in effect. The Monitor is required to file with the Court a report on the debtor’s business and financial affairs prior to the meeting of creditors, upon ascertaining any material adverse change in the debtor’s projected cash flow or financial circumstances or in such other circumstances as the Court orders. The Monitor is required to act independently and consider the interests of both the debtor and its creditors. The fees and expenses of the Monitor and its counsel will generally be a first charge on all of the debtor’s assets.

(c) The Plan - The debtor is granted leave to file with the Court a plan of compromise and arrangement (the “Plan”) with some or all of its creditors prior to the expiry of the stay of proceedings. Courts have granted security to post-filing suppliers of goods and services.

(d) Operations During the Proceedings - The debtor is generally given leave to continue carrying on business and pay post filing obligations arising in the ordinary course of business, subject to any restrictions set out in the Initial Order.

(e) Restructuring - The debtor is often authorized to sell assets within certain parameters and to terminate contractual arrangements with third parties such as real and personal property leases and license agreements. The claims of the third parties arising from the termination of the contractual arrangements are then dealt with under the Plan.

(f) DIP Financing - It is becoming more common for Initial Orders to provide for “debtor-in-possession” financing (“DIP financing”), secured by a charge on all of the debtor's property.

3. The Claims Process

After the Initial Order is made, the Court will order that the claims of creditors be quantified. The procedures for proving claims under the CCAA are determined by Court order, usually just before the Plan is sent to the creditors. Generally, the claims procedure is administered by the Monitor, subject to the supervision of the Court. Proof of Claim forms are distributed to all known creditors, who are required to submit their claims by a stipulated date in order to vote and to receive distributions under the Plan. The Monitor or the debtor will also advertise the claims process in appropriate newspapers. Once claims have been submitted, the debtor and the Monitor will review the claims and the debtor will either accept or reject them. If the debtor contests either its liability under the quantum of a claim, the issue is generally determined by either the Court or a claims officer on a summary application. If the claim is contingent in nature, and the debtor does not accept its quantum or existence, the debtor will reject the claim and the creditor must appeal the rejection. The onus of proving the claim is on the creditor. The debtor may also admit the full amount of a claim for voting purposes and reserve its right to contest liability for the purposes of distributions under the Plan.

In many cases the Court, as part of the claims process, will order that all claims must be submitted by a specified date, after which creditors will no longer be entitled to submit a claim or exercise any remedy against the debtor.

4. The Plan of Compromise and Arrangement

Both before and after the commencement of CCAA proceedings, the debtor will attempt to negotiate the terms of the Plan with its creditors. The debtor generally has the primary right to prepare and file the Plan. However, in certain circumstances the Courts have authorized either the Monitor or groups of creditors to file a Plan which they have prepared. Generally, this only happens when the creditors have completely lost confidence in the debtor’s management or when the debtor’s Plan has been rejected and the creditors convince the Court that their version of a Plan has a reasonable chance of being accepted.

A debtor will usually seek the informal support of its most important creditors or groups of creditors for the Plan prior to filing it with the Court. The process of obtaining such support can extend the drafting process over many months. Once the Plan has been prepared, the debtor will seek leave to file it with the Court and to distribute it to the creditors with an information package setting out the background of the proceedings and the basis of the Plan. The Monitor’s report will be distributed to the creditors with these materials.

CCAA plans are similar to those under Chapter 11. Generally, the Plan will divide creditors into classes based upon the nature of their claim against the debtor and the manner in which their claims are treated in the Plan. Creditors within a particular class must receive substantially equal treatment under the Plan. Different classes, however, typically receive different treatment under the Plan depending upon their bargaining strength, the nature of their claims and the value of any security they have. The manner in which the creditors’ claims are dealt with tends to be limited only by practicality and the ingenuity of the person drafting the Plan. The following are examples of how claims can be treated:

• Creditors having security over non-core assets may be given leave to enforce their security.

• The unsecured creditors may have the amount of their claim reduced, with payments being made in lump sums or over time.

• The unsecured creditors may have all or part of their claim converted into shares or other securities of the debtor.

• Certain creditors may be exempt entirely from the Plan and will continue to have all of their rights and remedies against the debtor (these are referred to as “unaffected creditors”).

Employees and key suppliers are often classed as unaffected creditors where the debtor intends to continue carrying on business (e.g. with unionized employees, the debtor would have to continue the Collective Agreement). Sometimes the debtor will seek to deny a class of creditors recovery by either actually or purportedly making them unaffected creditors.

A Plan may create a pool of funds for creditors whose claims are affected and provide for distribution of those funds among the classes of creditors on the basis set out in the Plan. A Plan may provide for the sale of all or a portion of the debtor’s assets and for the incorporation of a new entity for the purposes of continuing the business.

Claims against directors of the debtor may be compromised by a Plan where they arose prior to the commencement of the proceedings and relate to the obligations of the debtor, and where the directors are liable in their capacity as directors to pay such claims. However, it is not possible to compromise claims against directors which relate to the contractual rights of creditors, misrepresentations by directors or wrongful or oppressive conduct by the directors. Also, a Court will refuse to allow a compromise of claims against directors where such a compromise would not be fair and reasonable in the circumstances.

5. Meetings of Creditors to Vote on the Plan

Once the Plan is filed, the Court will order that meetings of each class of creditors be held. At the meetings, each class is given the opportunity to vote upon whether or not to accept the Plan. If a simple majority in number of creditors holding two-thirds in value of the claims in each class, who are present in person or by proxy and voting at the meeting, vote in favour of the Plan, the creditors will be deemed to have accepted the Plan.

6. Sanction of the Plan by the Court and Termination of the CCAA Proceedings

The Plan must then be sanctioned by the Court. At the sanction hearing, the Court will determine whether the statutory requirements under the CCAA for the Plan have been satisfied and will also hear any objections to the sanctioning of the Plan. Once sanctioned, the Plan is binding upon the debtor and any creditors affected by the Plan. Creditors may file objections to the sanctioning of the Plan. The burden of proof in showing the Plan should not be sanctioned is on the objecting creditor.

While the Court will avoid second guessing the creditors where the requisite majority in each class have voted in favour of the Plan, it will refuse to sanction a Plan if it is unfairly prejudicial to certain creditors, it is not economically feasible, the requirements of the CCAA have not been satisfied, or the Plan is not fair and reasonable. A Plan may be found to be not economically feasible where the availability of funds for distribution to creditors depends upon a contingency such as the business environment improving. In determining whether a Plan is fair, the Court will look to whether it is fair and reasonable to all participants generally and the objectors specifically. If there is nothing in the nature of a confiscation of the objector’s rights but rather a reasonable balancing of interests, the Plan should be approved. Courts have said that the test is whether an intelligent and honest person who is a creditor would approve the Plan, acting in accordance with his or her interests.
If the Plan is not accepted by the creditors or sanctioned by the Court, there is no automatic bankruptcy. In such cases, either the debtor or the creditors will apply to the Court for an order terminating the CCAA proceedings and/or the stay of proceedings. However, in order to avoid a chaotic liquidation, Courts will sometimes appoint a receiver and/or declare the debtor bankrupt prior to terminating the CCAA proceedings.

^[1] Insolvent persons can restructure pursuant to a proposal to the creditors under the Bankruptcy and Insolvency Act (Canada). It is also possible for insolvent corporations to restructure under other federal legislation such as the Winding Up and Restructuring Act (Canada), but that happens only in unusual circumstances.