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September 29, 2011 - Volume 2, Number 3

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Guarantor Waivers of PPSA Rights in British Columbia
By: Mike Todd (Vancouver)
(604) 891-2726
michael.todd@gowlings.com

Lenders should be aware that one of the waivers found in most standard form guarantees of certain statutory rights is not effective under the British Columbia Personal Property Security Act (“BCPPSA”).

This was the result in the recent BC Supreme Court decision HSBC Bank Canada v. Kupritz. The facts of that case are unremarkable. A trucking company went out of business leaving an unpaid debt to the bank of approximately $1 million. The bank was unable to recover that amount from the company’s assets and therefore sued the two principals of the company on their unlimited guarantees. One of the principals defended the claim on the basis that the bank had breached its obligations to him under the BCPPSA by failing to secure the company’s assets, improvidently realizing on the collateral seized, failing to provide notice of the impending sale of the collateral and failing to provide an accounting.

The guarantee contained the usual provision that no loss in security by the bank would lessen the guarantor’s liability under the guarantee. The bank therefore argued that the guarantor was precluded from asserting as a defence that the bank failed to properly realize on the collateral. However, the BCPPSA states that provisions in a security agreement or other agreement (such as a guarantee) that purport to exclude a duty under the Act are void, and that certain rights of a debtor cannot be waived by agreement. The court found that the prohibitions against contracting out of the protections under the BCPPSA apply not just to primary debtors, but also to guarantors. Based on this analysis, the court held that a guarantor cannot contract out of his or her statutory rights under the BCPPSA, and therefore the specific waiver of improvident realization in the guarantee did not prevent the guarantor from raising that defence against the bank.

The court then considered all of the circumstances surrounding realization by the bank and its receiver, and found that none of the bank’s obligations to the guarantor under the BCPPSA that were the subject of the waiver had actually been breached. As a result the guarantor was found liable to the bank on his guarantee, and judgment was rendered against him for the full amount of the primary debt remaining unpaid.

The important lesson for lenders from the case is that guarantors cannot waive the statutory rights given to them under the BCPPSA. A similar argument can probably also be made by guarantors in other Personal Property Security Act jurisdictions, but the court in this case did note some differences in the wording of the Ontario Personal Property Security Act which make the result less clear in that province. Despite that, lenders should be aware that not all provisions of a guarantee are enforceable as written, and that in BC in particular, a waiver of improvident realization claims by a guarantor of rights under the BCPPSA will not be effective.

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Pension Decision Raises Questions About Canadian DIP Loan Priority
By: Jeffrey Oliver (Calgary)
(403) 298-1818
jeffrey.oliver@gowlings.com

A recent decision of the Ontario Court of Appeal (Re Indalex Ltd., 2011 ONCA 265) has raised questions regarding the validity of the super priority status afforded to Debtor in Possession (“DIP”) financing in circumstances in which there is a statutory deemed trust arising out of a pension plan windup deficiency.  Although the decision is very fact specific, it nonetheless came as a surprise to many Canadian insolvency practitioners, who understood that courts would apply a priority scheme under the Companies' Creditors Arrangement Act, R.S.C. 1985, c. C-36 (“CCAA”) that was consistent with the scheme under the Bankruptcy and Insolvency Act, R.S.C.  1985, c. B-3, in which many such statutory deemed trust claims are inoperative.

FACTS

The Indalex group of companies were the second largest manufacturer of aluminum extrusions in the United States and Canada.  It was the sponsor and administrator of two registered pension plans: one for salaried employees (the “Salaried Plan”) and one for executive employees (the “Executive Plan”).

On April 3, 2009, Indalex and other Canadian companies in its corporate family obtained protection from their creditors pursuant to the CCAA.  As of the date of the commencement of those proceedings, the Salaried Plan and Executive Plan were both underfunded, and the Salaried Plan was in the process of being wound up.

Early in the proceedings, Indalex obtained a court order permitting it to obtain DIP financing.  Pursuant to that order, the DIP lender obtained a charge over all of Indalex’s assets in priority to all other claims.  The DIP loan was also guaranteed by Indalex’s parent corporation in the United States (the “Guarantor”).

There were ultimately insufficient assets to repay the unfunded liabilities in the Salaried Plan and Executive Plan.  At a hearing to approve the sale of Indalex’s assets, the United Steel Workers Union (“USW”), appearing on behalf of beneficiaries under the Salaried Plan, and a group of retired executives appearing on behalf of beneficiaries of the Executive Plan, asked for and obtained an order from the court requiring the Monitor to retain $6.75 million of the sale proceeds (the “Proceeds”) pending resolution of a priority dispute.  In particular, the USW and retired executives argued that the unfunded pension liabilities in both the Salaried Plan and Executive Plan should rank in priority to the court ordered charge securing the DIP loan, and as such the Proceeds should be used to fund those pension liabilities rather than repay the DIP loan.  The basis for this argument was, among other things, s. 57 of Ontario’s Pension Benefits Act, R.S.O. 1990, c. P.8 (the “PBA”), which creates a statutory deemed trust for “an amount of money equal to employer contributions accrued to the date of the wind up but not yet due under the plan or regulations”.

In light of the Court’s decision to require the Monitor to withhold the Proceeds, the Guarantor paid the $10.75 US million shortfall on the DIP loan to the DIP lender, making the DIP lender whole.  The primary secured creditor of the US parent company was then subrogated to the DIP lender’s rights to collect the Proceeds.

THE DECISION

At first instance, the CCAA judge held that the deemed trust provisions of the PBA were not applicable, on the basis that the Executive Plan was not being wound up, and the payments to the Salaried Plan to address its deficiency were not yet “due” or “accruing due” under the PBA or its regulations.  That decision was overturned on appeal.

With respect to the Salaried Plan, the Court of Appeal held that the deemed trust provided for in s. 57(4) of the PBA extended to the entire wind-up deficiency of the Salaried Plan.  Further, as Salaried Plan beneficiaries were not given notice of the DIP lender’s application to subordinate their deemed trust claim when it obtained approval for the DIP loan, and because full disclosure of the pension priorities issue was not placed before the judge when the DIP loan was approved, the Court held that the PBA deemed trust priority was not subordinated to the super priority DIP charge.  It should be noted, however, that the Court left open the possibility of the PBA deemed trust being subordinated to DIP charges on a “case by case basis”, citing as an example a circumstance in which “.. the application of the provincial legislation [ie. the PBA] would frustrate the company’s ability to restructure and avoid bankruptcy.”

With respect to the Executive Plan, the Court noted that as that plan was not being wound up as of the date of the asset sale, a deemed trust with respect to the Executive Plan appeared to be inconsistent with the PBA.  However, rather than making a definitive finding on that issue, the Court agreed with the USW and Former Executives that Indalex acted in a conflict of interest during the CCAA proceeding.  In particular, the Court held that during the course of the restructuring Indalex was duty bound as a debtor corporation to treat the interests of all stakeholders fairly when their interests conflicted, but ultimately was obliged to act in the best interests of Indalex.  Meanwhile, as a plan administrator, Indalex was also duty bound to act in the best interests of the pension plans’ beneficiaries.  Due to this conflict, the Court found that Indalex breached its fiduciary duties as plan administrator to the Executive Plan’s beneficiaries, and imposed a constructive trust over the balance of the Proceeds in favour of beneficiaries of that Executive Plan, in priority to the DIP charge.

An application for leave to appeal this decision to the Supreme Court of Canada is currently outstanding.  Clarification of the matters at issue will surely be well received by members of the insolvency, lending and pension industries.

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Retractable Shares: The Unexpected Creditor
By: Richard Dusome (Toronto)
(416) 862-5423
richard.dusome@gowlings.com

When structuring a new financing for a corporate borrower, lenders typically obtain postponements from all other creditors and shareholders advancing loans to the proposed borrower.  Postponements establish the lender’s priority to receive payment from the borrower vis-à-vis these other known creditors.

However, some shareholders who have not actually advanced loans to the borrower may still hold shares that contain a right of retraction that will require the borrower, at the shareholder’s option,  to purchase the retractable shares at a pre-arranged price following the issuance of an exercise notice.  The retraction serves to create a new debt obligation out of what was originally an equity holding. 

Ontario courts have held in some cases like Itak International Corp. v. CPI Plastics Group Ltd., that the existence of negative covenants in a loan agreement between a borrower and a lender prohibiting the making of any payment in connection with the retraction of shares are not effective as against the shareholder.  Those negative covenants will not preclude a shareholder from issuing a retraction notice and independently creating the debt obligation, and they cannot be used by the borrower to justify a refusal to make the payment. 

Thus, it is important to determine at the outset of a financing if the borrower is authorized to issue retractable shares, and if so, whether any such shares have actually been issued.  Lenders should then ensure that any holder of retractable shares provides a satisfactory postponement that will become operative if the retraction option is ever exercised.  This will avoid any surprise payment being made to an unexpected creditor that cannot be recovered by the lender from the shareholder in the absence of a direct contractual obligation created by a postponement.

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Spotlight on Security Documents: The Landlord Waiver
By: Richard Dusome (Toronto)
(416) 862-5423
richard.dusome@gowlings.com

Having enforceable security over all of a borrower’s assets is obviously of primary importance to a lender.  However, where a borrower occupies leased premises, ensuring the lender has quick and reliable access to the collateral is equally important, especially if the landlord proves to be unco-operative after a borrower’s default.  Although court-ordered access to a borrower’s leased premises can be sought after a borrower’s loan default, a landlord waiver obtained prior to an initial advance of a loan can bring some added certainty to the realization process outside of a bankruptcy.   

The provisions contained in a landlord waiver will vary depending upon the overall bargaining power of a borrower in terms of whether it is a single tenant of a large leased premises, or just one of many tenants in a multi-unit building where the rental income provided by the borrower is not material to the landlord’s business.

Ideally, a landlord waiver will include a waiver by the landlord of all of its present and future liens and rights of distraint against the inventory and other secured collateral of the applicable borrower.  This waiver will reduce the lender’s exposure to rental arrears that could arise after the loan is advanced.

An acknowledgment from the landlord that the collateral is deemed to be the personal property of the borrower and not a fixture of the leased premises is another key component of a landlord waiver.  This acknowledgment will ensure any collateral in the form of heavy machinery and similar assets do not inadvertently become fixtures that constitute property of the landlord as owner of the leased premises.

A landlord waiver will often provide a lender with the right to occupy the leased premises for a negotiated period of time for the purpose of possessing, removing or selling the collateral.  The lender will of course need to pay a negotiated amount of occupation rent for the right of easy access to the collateral, but it can generally avoid any responsibility for putting the lease back in good standing by paying all rental arrears and curing other lease defaults.

Finally, the landlord waiver will ideally include an obligation on the part of the landlord to obtain its mortgagee’s consent and agreement to comply with the terms of the landlord waiver.

There are many alternative provisions that can be negotiated into a landlord waiver to address any specific characteristics of a particular borrower or a particular leased premises.  But having a landlord waiver in advance of a borrower’s default at least gives the lender a better position to bargain from, as opposed to trying to negotiate access to the leased premises with the landlord after the loan is in default. 

Lenders should ensure their term sheets and commitment letters specifically refer to the requirement for the delivery of a landlord waiver in respect of each leased location of the borrower where a material amount of inventory and other collateral is located.    

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A Banker Asked Us: General Security Agreements from Individuals
By: Richard Dusome (Toronto)
(416) 862-5423
richard.dusome@gowlings.com

Q:        As part of my security package, I am obtaining an unlimited personal guarantee from the president of my corporate borrower.  Can I also take a general security agreement from that individual in Ontario to secure his/her personal guarantee?

A:        The answer really depends upon what type of assets you are looking to secure with the general security agreement.  A general security agreement typically calls for the debtor to grant a security interest to the lender in all of the debtor’s present and after-acquired personal property.

If that personal property consists of assets used primarily in connection with the operation of a business (for example, when the debtor is the sole proprietor of a small business), then it is possible to charge all present and after-acquired business assets of an individual with a general security agreement.

However, if the personal property to be secured consists of consumer goods (generally defined as goods used or acquired for use primarily for personal, family or household purposes), then Section 12(2)(b) of the Ontario PPSA precludes a security interest from attaching to consumer goods under an after-acquired property clause unless the debtor acquires rights to them within ten days after the secured party gives value.  Thus, an after-acquired property clause would simply not be effective over the natural term of any typical loan. 

In addition, the Ontario Consumer Protection Act places further restrictions on after-acquired property clauses and on the ten day allowance period referred to above vis-à-vis any of the borrower’s goods other than those acquired by the borrower from the lender.  There are also exemptions (which vary from province to province) which prevent a lender from seizing certain types of secured assets, including certain household furnishings, clothing, tools used to earn income and other assets within certain prescribed amounts.

In light of these restrictions on after-acquired property clauses affecting consumer goods, a personal guarantee from an officer or director of a corporate borrower is more customarily secured by a charge on his or her residence or recreational real property, or by a security interest granted over specific individual items of valuable personal property.

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Richard Dusome (Toronto)
Mike Todd (Vancouver)
Jeffrey Oliver (Calgary)
Richard Dusome (Toronto)
Robin Walker (Toronto)
Cara Sklar (Toronto)
Leslie McCauley (Toronto)
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