Canada’s highest court upholds the priority of financing charges in restructuring proceedings

October 2021  |  SPECIAL REPORT: RESTRUCTURING & INSOLVENCY

Financier Worldwide Magazine

October 2021 Issue

On 28 July 2021, the Supreme Court of Canada (SCC) upheld an Alberta Court of Appeal majority decision giving priority to court-ordered charges in restructuring proceedings, including secured charges in favour of interim lenders, over the Crown’s statutory deemed trusts for unremitted source deductions. While the SCC majority was clear that supervising judges should only give priority to interim charges in appropriate cases, it ultimately came down on the side of commercial certainty, thus resolving what had been a difficult history of tax priority litigation dating back to the mid-1990s or earlier.

The decision in Canada v. Canada North Group Inc. involved the restructuring proceedings of Canada North Group and six related corporations pursuant to the Companies’ Creditors Arrangement Act (CCAA). The initial court order giving protection to the debtors also provided certain ‘super priority’ charges: a financing charge in favour of the debtors’ interim lender, an administration charge for the fees of the debtors’ court-appointed monitor and counsel, and a charge in favour of the debtors’ corporate directors, known as the ‘priming charges’. When the debtors applied for the initial order, they gave evidence of approximately $685,000 owed by the debtors to the Crown for unremitted employee source deductions. The supervising judge ordered that the priming charges had priority “to all other security interests… charges and encumbrances, claims of secured creditors, statutory or otherwise”, and that they were not to be “limited or impaired in any way by… the provisions of any federal or provincial statutes”.

Based on the super priority of the priming charges, the interim lender advanced $900,000 of its $1m capped facility. A further application was then granted to increase the interim facility’s cap to $2.5m.

Only then did the Crown apply to the court to vary the initial order on the basis that the priming charges failed to recognise the Crown’s deemed trust created by federal taxation statutes to secure payment of the unpaid source deductions. The Crown argued that it had a proprietary interest, rather than secured interest in the debtors or the debtors’ property, which was not rightly subordinate to the priming charges.

The chambers judge dismissed the Crown’s application, rejecting the argument that the deemed trust provisions in the taxation statutes created a proprietary interest rather than a security interest. She considered the purpose of the taxation statutes alongside the overarching purpose and goals of the CCAA, and study findings to the effect that 75 percent of restructurings required support from interim lenders. As a result, the chambers judge concluded that giving priority to the Crown would introduce an unacceptable degree of uncertainty in Canadian restructuring practice.

“The interim financiers’ charge provides both an incentive and guarantee to the lender that funds advanced in the course of the restructuring will be recovered,” she noted. “Without this charge such financing would simply end, and with that, so too would end the hope of positive CCAA outcomes. Here, I digress to note the increasing prevalence of interim financiers having no prior relationship to the debtor. It does not take a stretch of imagination to forecast that this practice will diminish if not end altogether without the comfort of super-priority charges.”

The chambers judge concluded that the CCAA authorises the courts to rank interests such as the priming charges ahead of the Crown’s deemed trusts. The Crown appealed.

A majority of the Court of Appeal agreed with the chambers judge, finding that the Crown’s interest under the deemed statutory trust provisions of the taxation statutes is a security interest, not a proprietary interest that ranks ahead of the interests of all other secured creditors, but is nonetheless capable of being subordinated by the priming charges. Like the chambers judge, the Court of Appeal also noted the “unacceptable level of uncertainty” that would be injected into restructuring proceedings if the Crown’s argument prevailed. The Crown was granted leave to appeal to the SCC. Five of the nine SCC judges who heard the Crown’s appeal agreed that it should be dismissed, although those five judges authored two separate sets of reasons.

The lead decision contained several key findings in support of its conclusion that the priming charges ranked in priority to the Crown’s deemed trust. The Court found that the CCAA grants a supervising court broad discretionary power to make any order that it considers appropriate in the circumstances. Section 11 of the CCAA in particular is the source of the court’s authority to grant priming charges with priority over the Crown’s deemed trust interests. The deemed trust interest itself is not in the nature of a proprietary interest that removes property from a debtor’s estate. Accordingly, property that is subject to such a deemed trust can therefore become subject to a priming charge under the CCAA. Further, the Court noted that the taxation statutes do not give the Crown priority to all possible interests, but only security interests as defined by that legislation. A court-ordered priming charge is not a “security interest” within the meaning of that legislation and is therefore not automatically subordinated by the Crown’s deemed trust. Finally, the lead decision found that the supervising court’s authority to subordinate the Crown’s interest under these types of statutory deemed trusts to interests protected by priming charges is discretionary. In exercising this discretion, the court should recognise the distinct nature of the Crown’s interest and ensure that it grants a charge with priority over a deemed trust of the Crown only when necessary.

In separate concurring reasons, Karakatsanis and Martin JJ agreed that the Court of Appeal’s decision should be upheld. They agreed that section 11 of the CCAA can be used to give priority to priming charges ahead of the Crown’s deemed trust for two reasons. First, ranking the priming charges ahead of the Crown’s deemed trust interest does not conflict with the taxation statutes as long as the Crown is paid in full under a debtor’s plan of compromise in the restructuring proceedings. Second, granting priming charges with priority over the Crown’s deemed trust may be necessary to facilitate the objectives of the CCAA. In deciding whether to grant priming charges with such super priority, the supervising court must consider whether there is evidence that the priority charge is necessary to further the CCAA’s objectives.

Two separate sets of dissenting reasons were also authored by the SCC. The dissenting judges all shared the view that only one plausible interpretation could be given to the taxation statutes: the Crown’s deemed trust has priority over all other claims, including priming charges granted under the CCAA. The dissenting judges would have allowed the Crown’s appeal.

Overall, the SCC majority decision in Canada North is an important case in Canadian restructuring and lending practice, which confirms that priming charges in favour of interim lenders, monitors, counsel, or directors and officers, may rank in priority to the Crown’s statutory deemed trusts in appropriate cases. Given the predominance of interim lending, this decision brings a considerable amount of certainty into lending and borrowing in Canadian restructuring practice.

That said, the SCC’s reasons are clear that such a priority ranking is not automatic. Supervising courts are now directed to grant priming charges with priority over the Crown’s deemed trusts only “when necessary”, in recognition of the Crown’s distinct interests and considering the objectives of the CCAA. Where a debtor intends to request that priming charges have priority to Crown interests, it should be prepared to provide evidence and submissions demonstrating why the request is necessary and in keeping with the remedial aims of the CCAA. Template CCAA initial orders may have to be revisited and revised to reflect the SCC’s holding that priming charges are not to be presumptively prioritised ahead of the Crown’s interests under statutory deemed trusts, although they may be so prioritised in appropriate circumstances. Interim lenders will have to gauge their level of comfort with advancing financing that may rank behind certain Crown interests, and safeguards for interim lenders may now have to be drafted into interim lending agreements to manage the associated risk.

 

Aaron Stephenson is a partner and Meghan Parker is an associate at Norton Rose Fulbright Canada LLP. Mr Stephenson can be contacted on +1 (403) 267 8290 or by email: aaron.stephenson@nortonrosefulbright.com. Ms Parker can be contacted on +1 (403) 267 8211 or by email: meghan.parker@nortonrosefulbright.com.

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BY

Aaron Stephenson and Meghan Parker

Norton Rose Fulbright Canada LLP

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