If there’s one thing that can be said about cross-border insolvencies, it’s that they’re frequently rife with friction.
“The practical reality is that both sides of the border are there to make a profit,” says David Bish
, a lawyer in Torys LLP
’s Toronto office. “There’s a real tension there on the ground.”
This is especially so when it comes to Insolvency.
“You get situations where Canadian companies who have bricks and mortar operations file in the US as part of a large corporate group,” he says. “That can raise concerns for Canadian courts and insolvency professionals about the extent to which Canadian interests have become a second consideration in the American backyard and the extent to which value is being diverted to US shareholders.”
Not surprisingly, given the relative economies of the two countries, there are not nearly as many cases where the parent company is Canadian and trying to drive value northward.
“But there’s always that tension in any event,” Bish says.
Canadian courts have not been reluctant to express and act on the concerns arising from these tensions. A telling example is the decision of Justice Geoffrey Morawetz in Payless Holdings, Inc. LLC
, in which he refused to recognize the debtor-in-possession (DIP) financing facility granted in Payless’ Chapter 11 proceedings.
What troubled Morawetz was that the DIP facility encumbered assets of Payless Canada Group in circumstances where members of the Group were not borrowers under the facility and were neither borrowers not guarantors under the pre-filing facility with the DIP lender.
“Both Canada and the US have a great deal of respect for the principles of international comity, so it’s extraordinary for a Canadian court to refuse to give effect to a US order,” Bish says.
But it does happen and, as it turns out, Canadian courts have made it clear that they will not tolerate unfair prejudicial treatment even in the face of liquidity needs or international comity considerations.
It is here that the monitor, an officer of the court whose role is more or less unique to the Canadian system, plays an important role. The main function of the monitor is to report to the court on the debtor company’s ongoing financial situation and on its efforts to develop a plan of arrangement. But over the years the role has evolved and expanded so that the monitor, who must be a licensed bankruptcy trustee, has become the most important player under Canada’s restructuring statute, the Companies’ Creditors Arrangement Act
“Monitors’ reports have a lot of weight and have significant influence on the outcome of issues in the sense that these reports always inform the issue and often, but not always, determine it,” says Monique Jilesen
, a lawyer at Lenczner Slaght Royce Smith Griffin LLP
In cross-border proceedings, then, the monitor frequently functions as a watchdog for Canadian creditors.
The monitor, for example, was instrumental in obtaining an order protecting Canadian unsecured creditors in the Circuit City restructuring after a US court excluded certain US assets from the scope of a DIP security, a development that had the indirect effect of increasing Canadian creditors’ exposure.
And in the proceedings relating to White Birch Paper Holding Company, the monitor called the Quebec Superior court’s attention to the fact that the allocation methodology approved in the US could favor the company’s US subsidiary. The intervention eventually resulted in a settlement that was acceptable to the Canadian creditors.
Driving the discord is the fundamental philosophical difference between the regimes.
“The US has been very focused on codification and has attempted to legislate every foreseeable circumstance, whereas Canadian law is much more driven by judicial discretion,” Bish says.
Indeed, the Canadian system is often frustrating for American clients.
“All that discretion means we can’t just quote them black letter law,” says Robert Thornton
of Thornton Grout Finnigan LLP
in Toronto. “And saying that ‘we can do that under a particular section of Chapter 11’ is very different from telling clients that ‘we can convince a judge to do that.’”
It’s not that Canadians dealing with the American system don’t have their frustrations too.
Distribution of funds, for example, is a much more lengthy and complicated process in the U.S. Thornton cites one instance of a restructuring involving several related corporate entities.
“We would have dealt with the distribution in six weeks by using a distribution order,” he says. “But under Chapter XI, we had to file a plan and a disclosure statement for each company, a costly exercise that took about six months and ate away at the pot available for creditors.”
The values by which plans are approved vary too: in Canada, process rules, but in the US, price rules.
“The Canadian view is to do as much as you can in the boardroom and only go to court if you have to,” Thornton says. “So our restructurings are done almost entirely by way of negotiations outside the courtroom, which most often culminate in a pre-packaged settlement that the monitor puts to the court for approval.”
In the US, however, no agreement is secure if a better bid appears.
“Even if that better bid arrives at the last moment at the courthouse door, the deal reached can be trumped,” Thornton says. “But in Canada, so long as the process has been open and transparent with full disclosure, the deal will stand even if someone comes up with a better bid.”
One aspect of the US system, however, has considerable appeal to Thornton. It’s known as the “cramdown” and refers to the imposition of a reorganization plan by a court despite objections by certain classes of creditors.
“Here, every class of creditor must approve the plan because our law doesn’t allow for the bifurcation of creditor classes,” Thornton explains. “But in the US, there is the ability to arrange classes of creditors into subclasses, and if any one subclass accepts the plan, its members can cram the plan down on everyone else.”
However, many lawyers believe the systems are converging.
“Originally, the processes in the two systems were not very well lined up,” says Jay Carfagnini,
a lawyer at Goodmans LLP
in Toronto. “But nowadays, my belief is that the differences are more related to process and style than to substance. In the end, the CCAA and Chapter 11 achieve the same results, and I’m not sure the differences between them are fundamental.”
Over the years, it seems, the systems have overlapped and adapted to each other.
“DIP financing, for example, is something that had its roots in the US but has become a very positive addition to the CCAA process,” Carfagnini notes. “Conversely, US debtors were originally very guarded about our use of the monitor, because their processes were still characterized by adversarial litigation. But nowadays, US judges are even asking for the monitor’s position on issues that come up in their jurisdiction.”
Carfagnini credits the international restructuring bar for the convergence and success of cross-border restructurings.
“The bar around the world has been very active in coordinating and facilitating educational activities in which the judges and lawyers get to know one another and understand each other’s systems, with the result that more and more cases are resorting to cross-border protocols for the benefit of all stakeholders,” he says.
Still, the question remains: which system, Canadian or US, is best?
Ever the lawyer, Thornton would say it depends on the case.
“Some cases are better with rigidity, and some are better with flexibility,” he explains. “But empirical evidence suggests that on average, Chapter 11 proceedings are about 50 percent longer and 10 times as costly as CCAA proceedings.”
Those numbers are correct, Bish agrees, but there is a price for efficiency.
“We’re faster and cheaper but at the expense of process,” he says. “What’s most interesting, however, are the politics between the lawyers from the two countries and how that plays out — especially when people are trying to manipulate who’s going to control the agenda.”