DIP priority – who’s on first?

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Canada’s insolvency laws have, perhaps, one characteristic in common with democracy.

Sir Winston Churchill said, “democracy is the worst form of government, except for all the others.” (He wasn’t the first to say it, but he was Churchill.) The same ambivalence may well sum up the feelings of those who deal regularly with Canada’s insolvency laws.

The workings of the Companies Creditors Arrangement Act (CCAA) and the Bankruptcy and Insolvency Act (BIA) can sometimes appear downright perverse — but they have a relentless logic all their own. Aimed at making the best of a bad situation, it may be inevitable that the two statutes have very few unstinting admirers.

Scarce assets

Their first objective is to return financially distressed companies to solvency; thereby preserving jobs, the tax base and the capacity to service debts. Failing this, they aim to sort out who gets what from the assets of failed enterprises. Either way, the CCAA and BIA (for companies with debts under $5 million) make the courts more or less benevolent arbiters (dictators?) over all the conflicting interests in situations where assets do not match liabilities.

In Canada North Group v. CRA, the Canada Revenue Agency argued that it’s deemed trust, granted under the Income Tax Act (ITA), should be given priority over debtor-in-possession (DIP) financing approved by the court as part of a CCAA restructuring proposal for Canada North Group. DIP loans are fairly routinely approved in CCAA proceedings to provide working capital for distressed companies attempting to restructure and return to profitable operations. Lenders make DIP loans because the court awards them a “super-priority” on the assets of the debtor company.

CRA’s contention in Canada North Group was that unpaid payroll tax deductions are a priority charge that must be paid before DIP financing, even though the tax department conceded that such a ruling would place a “chill” on future restructuring efforts.

CCAA primacy

The Alberta Court of Queen’s Bench (ABQB) said that the Supreme Court of Canada had already commented on the logic of DIP lending in Indalex, noting “The harsh reality is that lending is governed by the commercial imperatives of the lenders ….” In other words, no one would lend to a company in the throes of insolvency without a court’s assurance of a super-priority on the borrower’s assets.

The ABQB also observed that it’s the objective of the CCAA to save distressed companies so that they can live to pay wages and income taxes in the future and that the CRA failed to take this into account (emphasis added). The ABQB ruled that courts must retain the power “to grant priority only to those charges necessary for restructuring.” That decision has been appealed to the Alberta Court of Appeal.

The issue of priorities in insolvency and bankruptcy remains extremely complex, with various questions before the courts. Where insolvency is an issue, borrowers and lenders should consult an experienced insolvency lawyer.

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