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Secured Creditors Not So Secure: Managing Pension Risk in Canada after Indalex

Although sometime has passed since the Ontario Court of Appeal surprised the pension, bankruptcy and insolvency community in Canada with its decision in Re Indalex Limited[1]in April 2011, the impact has remained at the forefront for Canadian and cross-border attorneys dealing with pension deficiencies and priority rules in Companies’ Creditor Arrangement Act (CCAA) restructurings. The court of appeal ruled that beneficiaries under salaried and executive defined benefit-pension plans were entitled to the proceeds of sale of the company’s assets to cover shortfalls in their under-funded pension plans in priority to Indalex’s debtor-in-possession (DIP) lender. Now that the Supreme Court of Canada has agreed to hear the appeal, secured lenders and other stakeholders should continue to monitor their interests when dealing with a (distressed) company with a defined benefit-pension plan in a deficit position until the case is heard, most likely in late 2012 or early 2013. Further, if the decision is not overturned, stakeholders should be prepared for life after Indalex.

Background
Indalex was the sponsor and administrator of two underfunded defined-benefit pension plans (salaried and executives). Indalex commenced restructuring proceedings under the CCAA on April 3, 2009. At the time of the CCAA filing, the combined pension shortfalls was $6.75 million. Indalex obtained DIP financing during the CCAA proceedings, secured by a court-ordered “super-priority” charge over Indalex’s assets ranking in priority to all other security interests, trusts, liens, charges, statutory or otherwise of Indalex. Indalex’s obligations under the DIP loan was guaranteed by its U.S. parent.

On July 20, 2009, Indalex sought court approval to sell its assets on a going-concern basis. At the hearing, representatives of the pension plan beneficiaries of the salaried and executive plans sought and obtained an order requiring the Monitor to retain $6.75 million of the sale proceeds in reserve.

On closing, the proceeds of sale were insufficient to repay the DIP lenders, and Indalex-U.S. satisfied the balance owing to the DIP lender under the guarantee. The estate of the U.S. parent argued that it was entitled to the reserve as it was subrogated to the position of the DIP lenders under the super-priority charge. The plan beneficiaries representatives argued that the beneficiaries were entitled to the reserve based on deemed trust provisions of the Ontario Pension Benefits Act(PBA). The lower court found that none of the funds in question were subject to a deemed trust under the PBA. Subsequently, both pension plan groups appealed.

Court of Appeal Decision
The lower court decision was overturned by the Ontario Court of Appeal, which ordered that the reserve funds be paid to the employee and executive pension plan beneficiaries for the following reasons:

  • The court found that the statutory PBA-deemed trust provisions on wind-up apply to the full wind-up deficit, departing from prior jurisprudence, which held that the deemed trust provisions in the PBA only applied to contributions accrued and due on the date of wind-up.
  • Notwithstanding that the CCAA court order provided that the super-priority DIP charge ranked ahead of trusts, the court found that the deemed trust ranked ahead of the DIP charge. The court of appeal did not enforce the super-priority charge, as the issue of “paramountcy” had not been addressed by the CCAA court, and the charge could not trump the priority of the deemed trust under provincial legislation.
  • The court, in holding that the beneficiaries of the executive plan (who were not entitled to the deemed trust provisions as the plan was not being wound up) were also entitled to the reserve in priority to the U.S. estate, imposed a constructive trust on the reserve in their favor because Indalex had been in breach of its fiduciary duties as employer/administrator under the plans.

Court of Appeal Decision Reasons
Deemed Trust Applies to Full Amount of Windup Deficiency
The Ontario Court of Appeal found that under §§ 57(4) and 75(1)(a) of the PBA, all amounts owing to the pension plan on windup are subject to a deemed trust, even amounts not yet due under the plan. The court ruled that the CCAA judge was incorrect in his application of the PBA, stating that "employer contributions accrued to the date of wind up but not yet due"[2] in § 57(4) include all amounts which will be owed by the employer on the wind up of its pension plan, even if they are not yet due.

Deemed Trust Ranks Ahead of DIP Financier
In rejecting the argument that the super-priority charge of the DIP financing ranked ahead of the deemed trust, the court of appeal noted that a CCAA judge has the authority and can grant a super-priority charge to DIP lenders that overrides provincial legislation, like the PBA. However, there has to be adequate notice and express recognition of priority in court materials to demonstrate that the federal and provincial laws are incompatible. In the lower court, paramountcy was not raised, and as a result the court of appeal held that the super-priority charge did not override the PBA’s deemed-trust provisions.

Fiduciary Duty Owed to Plan Beneficiaries and the Corporation
The court of appeal found that Indalex, as plan sponsor and administrator, had two conflicting roles—best interests of plan members vs. best interests of the company. The court found that Indalex breached its fiduciary duties to the beneficiaries of the plans as administrator under the PBAas it did nothing to protect the best interests of the plan beneficiaries and ignored its obligations as administrator after it filed for CCAA protection. The court found that a constructive trust applied to the sales proceeds that were to be used to fund the full amount of the pension plan deficiencies. The court of appeal found that Indalex undermined the beneficiaries by (1) applying for CCAA protection without notice to plans’ beneficiaries; (2) obtaining the CCAA order for the super-priority DIP financing without notice to the plans’ beneficiaries; (3) failing to raise the issue of paramountcy; (4) failing to protect the rights of the pension plan beneficiaries; and (5) selling the assets without making any provisions for the plans.

Implications
Indalex has raised important considerations as an arguably new priorities regime has been created and more complex fiduciary duties have been placed on company officials where the company acts as pension administrator. Pending the Supreme Court of Canada’s decision, here are a few considerations for stakeholders.

Front-End Solutions at Time of Extending Credit by Lenders
Solutions at the time of extending credit to a company with a defined benefits pension plan may include conducting more enhanced due diligence on the plans including (1) is the employer the pension plan administrator and sponsor?, (2) are current service payments in arrears?, (3) are the pension plans underfunded or at risk of becoming underfunded?, (4) what is the size of the deficiency based on pension plan liquidity and solvency reports?, and (5) will the lender be paid out in full, even if its security is subordinated to the pensioners? Other solutions may include revising loan documents to include covenants/conditions to minimize pension exposure, obtaining from unions/plan beneficiaries acknowledgements of lender’s senior priority as a condition to financing, making the appointment of a new plan administrator a condition to financing, and requiring the conversion of borrower defined benefit plans to defined contribution plans as condition of financing.

Loan Administration Solutions for Lenders
Solutions for lenders include (1) enhanced monitoring of pension deficiencies, (2) setting up pension reserves, (3) having disclosure provisions in loan documents for pension developments and (4) policing loan covenants relating to pensions.

Court Proceedings
Where court proceedings are contemplated (enforcement or restructuring), moving parties should consider (1) notice and full disclosure to plan beneficiaries at the time of the commencement of the proceeding; (2) notice and full disclosure to plan beneficiaries at the time of priority-funding motion such as a DIP motion in court materials of the intent for DIP lender’s security to trump deemed trust provisions on grounds of paramountcy by more explicit language being drafted into orders than currently exists under model orders prescribed by Ontario Court; or (3) compromise of pension deficiency through negotiated plan of arrangement.

Appointment of a New Plan Administrator
Company executives may need to consider having an independent plan administrator where a restructuring filing is being considered.

Other Considerations
Other considerations might include negotiations with unions or non-union plan beneficiaries to deal with deficiencies to either eliminate or reduce their size or convert plans to defined contribution plans; or make concessions as to priority to contribution a requirement for future loans. Until the Supreme Court of Canada clarifies the law, lenders who do proceed with such financings, need to protect themselves by Indalex-proofing their financings.

 

1. [2011] ONCA 265.

2. Id. at paragraph 101, [2011] ONCA 265.




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