Creditor Rights and the Public Interest: Restructuring Insolvent Corporations 9781442673595

Table of contents :
Contents
Acknowledgments
Introduction
1. The Existing Regime for Restructuring Insolvent Corporations
2. Current Theoretical Approaches to Insolvency Law
3. Proposing a Conceptual Framework for Reconciling Stakeholder Interests
4. Judicial Discretion under the CCAA
5. Algoma Steel Corporation: Recognition of Human Capital Investments
6. Judicial Recognition of 'Social Stakeholders' in CCAA Proceedings: Anvil Range Mining Corporation
7. Competing Public Interest Considerations: Canadian Red Cross Society
8. Canadian Airlines Corporation and the Public Interest
9. International Comparisons: Creditor Rights and the Public Interest
10. Conclusion: Future Development of the Public Interest within the Enterprise Wealth Maximization Model
Conclusion
Notes
Index

Citation preview

CREDITOR RIGHTS AND THE PUBLIC INTEREST: RESTRUCTURING INSOLVENT CORPORATIONS

Creditor Rights and the Public Interest explores the process of restructuring insolvent corporations in Canada. Arguing in favour of the representation of such non-traditional creditors as workers, consumers, trade suppliers, and local governments, Janis Sarra describes the existing process of addressing their interests under the federal Companies' Creditors Arrangement Act (CCAA). In her discussion, Sarra draws on a large body of academic literature on a broad range of topics, including insolvency theory, corporate governance theory, legislative history, and bankruptcy and insolvency practice. She also surveys the relevant legislation and supplements her analysis with insights gained from extensive primary research of court records and personal interviews with lawyers, judges, and government officials. To illustrate trends in restructuring law, the author presents four case studies that focus on non-creditor groups, and compares the Canadian approach to that of several other countries, including Germany, France, and the United States. Creditor Rights and the Public Interest shows how the concept of the 'public interest' can be used to address the concerns of non-traditional stakeholders. Ultimately, Sarra makes a strong case for recognizing these creditors by situating insolvency law in a legal regime that realizes a duty to maximize all of the interests and investments at stake in the corporation. JANIS SARRA is an assistant professor in the Faculty of Law at the University of British Columbia. She teaches courses in corporate law, insolvency law, and contracts.

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CREDITOR RIGHTS AND THE PUBLIC INTEREST Restructuring Insolvent Corporations

Jam's Sana

UNIVERSITY OF TORONTO PRESS Toronto Buffalo London

www.utppublishing.com University of Toronto Press Incorporated 2003 Toronto Buffalo London Printed in Canada ISBN 0-8020-8754-X (cloth) ISBN 0-8020-8559-8 (paper)

Printed on acid-free paper

National Library of Canada Cataloguing in Publication Sarra, Janis Pearl, 1954Creditor rights and the public interest: restructuring insolvent corporations / Janis Sarra. Includes bibliographical references and index. ISBN 0-8020-8754-X (bound). ISBN 0-8020-8559-8 (pbk.) 1. Bankruptcy - Canada. I. Title.

2. Corporate reorganization - Canada.

KE1485.S268 2003 346.71078 KF1536.ZA2S268 2003

C2003-900897-5

This book has been published with the help of a grant from the Humanities and Social Sciences Federation of Canada, using funds provided by the Social Sciences and Humanities Research Council of Canada. The University of Toronto Press acknowledges the financial assistance to its publishing program of the Canada Council for the Arts and the Ontario Arts Council. University of Toronto Press acknowledges the financial support for its publishing activities of the Government of Canada through the Book Publishing Industry Development Program (BPIDP).

Contents

Acknowledgments Introduction

ix

3

1 The Existing Regime for Restructuring Insolvent Corporations 10 Origins of the Canadian Restructuring Regime 11 Overview of the Canadian Insolvency Restructuring Regime 17 Proposals under the BIA 19 Plans of Arrangement or Compromise under the CCAA 24 Challenges Posed by Judicial Oversight of the CCAA 28 2 Current Theoretical Approaches to Insolvency Law 30 Market Theory Approaches to Insolvency 34 Debt Collection Theory 37 Rehabilitation Theory 42 Enterprise Theory in the Governance of Insolvent Corporations 46 Effective Corporate Governance in the Turnaround of the Insolvent Firm 51 Achieving the Policy Objectives 51 Measuring the Effectiveness of the Policy Instruments 52

vi Contents 3 Proposing a Conceptual Framework for Reconciling Stakeholder Interests 56 The Convergence and Divergence of Stakeholder Interest 57 Public Policy Recognition of the Value of Workout Schemes 66 Workers as Equitable Investors with Enhanced Decision Rights 69 Assigning a Value to Human Capital Investments 77 Participation and Decision Rights That Flow from Valuing Equitable Claims 81 Negotiating Outcomes to Protect Investments and Create Future Value 85 An Expanded Definition of Stakeholders 89 The State 90 Local Trade Suppliers 94 Tort Claimants 94 The Nature of Community and Other Stakeholder Interest 95 Alternative Strategies for Recognition of Equitable Interests 98 Enterprise Value Maximization as a Substantive Objective of Insolvency Law 100 Directors to Act in the Best Interests of the Corporation Having Regard to the Investments of All Stakeholders 101 Principles for Reconciling Traditional Creditors' Rights with the Public Interest 106 The Role of the Judiciary in Reconciling Differences 110 4 Judicial Discretion under the CCAA 113 Judicial Recognition of the Public Interest 114 Purposive Interpretation or Judicial Overreach? 115 Use of the Stay Process to Recognize Diverse Interests 120 Debtor-in-Possession Financing 125 Definition of Classes as a Tool to Facilitate Restructuring 132 The Sanctioning of the Plan of Arrangement or Compromise 134 Ontario's Case-Managed System: Effective Judicial Oversight of Restructuring 140 Court-Appointed Officers and the Governance of Insolvent Corporations 143 The Monitor 144 Chief Restructuring Officers 146 Med-Chem and the Governance Role of Insolvency Professionals 148

Contents vii 5 Algoma Steel Corporation: Recognition of Human Capital Investments 157 The 1991-2 CCAA Restructuring of Algoma 158 Court Ordered Mediation as a Key Element in the 1991-2 Restructuring 160 Co-determination as an Integral Part of the Restructuring Plan 161 Recognition of Community as Stakeholder in the 1991-2 CCAA Proceeding 163 The 2001 CCAA Application of Algoma Steel Corporation 164 The 2001 Plan of Arrangement and Reorganization 166 Governance under the 2001 Plan of Arrangement 169 Lessons for Stakeholder Use of CCAA Processes 173 6 Judicial Recognition of 'Social Stakeholders' in CCAA Proceedings: Anvil Range Mining Corporation 181 Curragh Inc/s CCAA Proceeding 182 Anvil Range Mining Corporation: Concurrent Restructuring and Receivership Proceedings 184 The Court's Express Recognition of 'Social Stakeholders' 187 Preserving the Public Interest 192 7 Competing Public Interest Considerations: Canadian Red Cross Society 195 Sale of Assets in Advance of Court Approval of a Plan Adjournment to Allow for Meaningful Participation 199 Effective Use of Mediation/Arbitration to Settle the Pension Claims 202 The Red Cross Plan of Arrangement 205 Lessons for Stakeholder Participation 211 Competing Public Interests 214 8 Canadian Airlines Corporation and the Public Interest 217 Canadian Airlines' Insolvency and Workout 218 The Canadian Airlines Restructuring Plan 219 Classification of Creditors 221 Oppression Claims and the 'Fairness' Inquiry 224 Lessons for Judicial Consideration of the Public Interest 226

viii Contents 9 International Comparisons: Creditor Rights and the Public Interest 229 Public Policy Objectives of Workouts 231 Rehabilitation and Chapter 11 of the U.S. Bankruptcy Code 232 Workouts in France: Early Intervention to Protect Stakeholder Interests 237 Enterprise Wealth Maximization as an Objective of Insolvency Law 240 Recognition of Stakeholders' Equitable Investments in the Firm during the Restructuring Process 244 Tort Claimants under U.S. Chapter 11 Proceedings 245 Workers, Unions and Section 1113 of the U.S. Bankruptcy Code 247 Recognition of Human Capital Investments in France 250 Reconciling the Rights of Traditional Creditors and Other Stakeholder Interests 251 Lessons from Creditor-Oriented Jurisdictions 255 Germany's Insolvency Act 257 The System of Administration in the United Kingdom 261 Conclusion 267 10 Conclusion: Future Development of the Public Interest within the Enterprise Wealth Maximization Model 269 Developing Notions of Enterprise Wealth Maximization 271 The Public Interest in Encouraging Restructuring 274 Recognition of Stakeholder Interests 277 Reconciling Interests of Public Interest Stakeholders with Those of Traditional Creditors 284 Cross-Border Insolvency Proceedings and Implications for the Public Interest 285 Federal Legislative Review and the Implications for an Enterprise Wealth Maximization Model 289 Conclusion 295 Notes

297

Index

337

Acknowledgments

My sincerest appreciation to Michael Trebilcock, University of Toronto, Faculty of Law, for his helpful advice and support in this project. I was also greatly assisted by the support and encouragement of members of the British Columbia, Ontario, Alberta and Quebec courts. In particular, I would like to thank Mr Justice Robert Blair and Mr Justice James Farley of the Ontario Superior Court of Justice (Commercial List) who generously allowed me access to court files, hearings, chamber appointments, and pre-trials over a three-year period, as well as offering their insightful comments on a draft of this book. I would also like to thank Karen Gross, New York Law School, for her incredible generosity in reading the book and sending detailed comments from Europe. Thanks also to Karl Klare of Northeastern School of Law, Patrick Macklem, Kevin Davis, and Tony Duggan of University of Toronto, Faculty of Law, and Geoffrey Morawetz, Ronald Davis, and Michael Kainer of the Ontario bar for taking the time to read and critique the draft. There are also insolvency counsel and other participants in CCAA proceedings who generously shared their time and ideas on restructuring issues: The Honourable Lloyd Houlden, former Justice of the Ontario Court of Appeal; Edward Sellers, David Baird, Fred Myers, Yoine Goldstein, Gerry Kandestin, Bruce Leonard, Brian Empey, James Grout, Pat McCarthy, Joseph Latham, Bob Armstrong, Mario Forte, Derrick Tay, Paula Turtle, Steven Boniferro, Kenneth Delaney, Hugh MacKenzie, Arturo Alcalde, Bonnie Tough, Cameron Nelson, Mary Ann Haney, Kevin McElcheran, Jay Carfagnini, Mahesh Uttam-

x

Acknowledgments

chandani, David Wood, John Sandrelli, John McLean, and Ian Fletcher. For those mentioned only in notes or who asked not to be identified, my thanks also. My appreciation to Elizabeth Warren and Bruce Markell of Harvard Law School for generously taking the time to debate some of the issues canvassed here and for facilitating access to the Harvard Law Library. University of Toronto faculty members Jacob Ziegel, Brian Langille, Ron Daniels, and John Hagan were helpful in early stages of my research. Maitre Annie Planchard, Tribunal de Commerce, France was extremely helpful in sharing her experience and views in respect of the French insolvency regime. In terms of administrative support, my thanks to Rose Bava, Bruna Bava, Daina Green, June Fraser, and Allan Macmnis of the court office, the staff at the Ontario Constitutional Law Division, the federal Parliamentary Library, the Ontario Legislative Library and the National Library, and to the editors at the University of Toronto Press for their helpful assistance. Finally, my deepest thanks to my partner Book, my children Samantha, Danielle, and Alexander, and my parents Frank and Lucy Clarke for their continuing support.

CREDITOR RIGHTS AND THE PUBLIC INTEREST: RESTRUCTURING INSOLVENT CORPORATIONS

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Introduction

The effects of corporate financial distress extend far beyond the potential losses to shareholders. Long-term employees can lose their jobs. Local suppliers face the loss of an important market for their products. The cost of commercial credit can increase and its availability lessen. Governments and communities are potentially subject to the loss of tax revenue from decreased economic activity and face the prospect of increased adjustment costs in unemployment and welfare benefits. It is little wonder that news of a corporation's financial distress captures the public's attention. Is the public's role that of a mere onlooker? Historically, the fate of a financially distressed corporation has been treated as a matter of private law to be settled on the basis of the contractual claims of secured creditors. This book explores recent developments in Canadian insolvency law that treat the fate of financially distressed corporations as a matter of public law implicating the 'public interest.' Non-traditional creditors such as employees, tort claimants, and governments have been granted recognition and participation rights by the courts in insolvency proceedings. This recognition and participation is justifiable when one looks at those groups with both investments at risk and the potential to make contributions to the future value of the corporation. There is no shortage of empirical evidence that firm failure can create unprecedented losses to multiple stakeholders. Algoma Steel, one of Canada's largest steel manufacturers, has been in financial distress twice in the past decade, placing more than 5,000 direct and 23,000 indirect jobs at risk.1 White Rose's insolvency involved 2,600

4 Introduction employees, 1,200 suppliers, and over $78 million in debt in its plant nursery and retail operation.2 Consumers' Packaging Inc.'s financial distress placed the Canadian glass container market at risk, because the corporation supplied 82 per cent of the national domestic market and thus jeopardized more than 2,400 jobs and the spin-off industries dependent on a cost-effective source of glass containers.3 Anvil Range Mining Corporation accounted for 25 per cent of the gross domestic product of the Yukon prior to the insolvency of its mining operations. The Canadian Red Cross urgently needed to devise a survival strategy when it faced personal and class actions launched by more than 10,000 people suffering health effects from blood contamination. More recently, the crisis in the Canadian airline industry has placed thousands of jobs at risk and created considerable public concern for a continued viable national transportation system. However, financial distress does not inevitably lead to economic meltdown. Debtors and creditors alike frequently try to devise a survival strategy for a firm in trouble in order to maximize its realizable value. Federal insolvency legislation has consequently become a vitally important mechanism for the restructuring and governance of insolvent corporations. Canadian law has created what has been described as a 'secured creditor-friendly' regime for the enforcement of claims, liquidation, and the distribution of assets of the insolvent or bankrupt corporation. This creditor-directed process is tempered somewhat by a statutory scheme that allows corporations the opportunity to restructure their affairs and make compromises and arrangements with their creditors in an attempt to alleviate the financial problems. The statutory provisions of the Companies' Creditors Arrangement Act (CCAA) are aimed at allowing corporations to propose viable business plans that are acceptable to creditors. Legislative debates and recent case law have suggested that there is an element of the 'public interest' in the outcome of restructuring proceedings. This public interest is rarely defined, yet the parties traditionally before the courts, the debtor corporation and secured creditors, have frequently relied on notions of public interest to advance their particular positions. The individuals and groups that arguably comprise part of that public interest - trade suppliers, workers, local governments, and others - have not been active in the restructuring process until recently. While accurate quantitative data on the number of CCAA cases continues to be elusive, it is

Introduction 5

clear that these restructurings have a significant impact on Canada's economic health. The courts' more express recognition of the public interest in corporate workouts is a positive development, and one that should be encouraged, but it deserves more careful definition. There is a continuum of interest for various stakeholders in the successful turnaround of a firm. These interests should be expressly recognized and accorded a role in the process. Just as for solvent corporations, the central corporate governance challenge in insolvency restructuring is how to allocate risks and benefits, decision and control rights. These allocations must recognize who has investments at risk in the corporation, the priority among their interests, and who has the incentive to develop a business and restructuring plan that will create value for the corporation. This book explores the rationale for this development and the means by which this recognition can be accomplished. The emergence of the CCAA as an important commercial tool has led to a proliferation of cases in which the courts have given direction on the definition of classes of creditors for purposes of voting on proposed plans; the rights of various parties to participate in the restructuring process; and the statutory standards to be met for sanctioning of plans of arrangement or compromise. These cases have been accompanied by an increase in thoughtful commentary on the CCAA as an effective tool to assist private parties in their workouts. One area that has received little scholarly attention is the issue of what rights or role should be accorded in the CCAA process to non-traditional creditors or stakeholders, that is, to the workers, local governments, trade suppliers, consumers, tort claimants, and others who may have an interest in the corporation. Examination of these questions is particularly relevant at this juncture in the history of Canadian insolvency law. First, the courts have recently accorded a greater role to workers, their unions, and other stakeholders by express recognition of 'social stakeholders' and the 'public interest' in restructuring proceedings. While this is an important development, the concept of public interest and the role of non-traditional creditors require further conceptualization. Second, this discussion is timely because of the increasing prevalence and serious consequences of economic failure of Canadian corporations. The past two decades have witnessed unprecedented mergers and acquisitions, highly leveraged financial structuring of

6 Introduction

corporations, trade liberalization, and the consequent intensified product market pressure and erosion of market share. Firm failure has resulted in part from the inability of firms to adapt quickly to deregulation; technological, product, and organizational change; and globalization of capital and labour markets.4 These trends, combined with increased environmental and tort liability, resulted in a number of firms becoming insolvent. This book is particularly timely because the Canadian government is currently engaged in review and revision of insolvency and bankruptcy legislation. While the government is conducting a public consultation process, many of those arguably implicated in the public interest are not involved in these consultations. Unless there is a more fulsome discussion of the policy objectives and instruments of the CCAA, secured creditor interests are likely to prevail in the legislative review process. The public policy developments of the past decade are at risk of being undermined, because stakeholders who are frequently implicated in a firm's financial distress do not have the information or resources to champion public interest objectives during the legislative process. For corporations seeking protection under the CCAA or other restructuring vehicles pending approval of a plan of arrangement, compromise, or proposal, decision making should be undertaken in the best interests of the enterprise, having regard to all the interests and investments at stake. This is not to suggest that l^est interests' might not ultimately be defined as a sale of the business or piecemeal liquidation of the assets of the corporation. However, in advance of such a determination, there ought to be express recognition of the diverse interests at risk and a role for those interests in determining whether an economically viable workout is possible. The focus here is primarily on the CCAA, because it is the process by which the most significant Canadian reorganizations are currently undertaken. This statutory mechanism also affords both the courts and the parties involved the greatest flexibility in recognizing all those who have an interest in the viability of a corporation. The research methodology for this book was multifaceted. Both the court files and the actual judgments rendered by the court in all major CCAA cases of the past decade were studied. The Ontario Superior Court of Justice, Commercial List, generously afforded access to files, pre-hearing meetings, and numerous hearings on CCAA cases from 1998 to 2002. Legal scholarship from the United States and other ma-

Introduction 7

hire insolvency regimes provided theoretical grounding. Interviews were conducted with more than sixty individuals in five provinces who have recently been involved in CCAA restructurings, including insolvency practitioners, managers, workers, trade union representatives, and judges. Such interviews were important, because much of the decision making in insolvency workouts occurs outside of the courtroom and the public's view. William Mills has commented on the value of unpublished decisions as 'law/ and unreported judgments are particularly useful in the insolvency context, where anecdotal evidence reveals both the complexity and the value of workout negotiations.5 Although the interviews are too few to permit quantitative conclusions, they shed considerable light on the current strengths of Canada's restructuring regime and on the powerful dynamics of insolvency workouts. Chapter 1 discusses the origins of Canadian restructuring law, suggesting that the CCAA originally envisioned consideration of interests broader than those of shareholders and traditional creditors, but left the means by which this should be accomplished to judicial decision making. The chapter then provides a brief overview of the current restructuring regime. Chapter 2 canvasses theoretical debate on creditor and shareholder interests in the insolvent corporation and the governance issues that are raised. Chapter 3 sets out a conceptual framework for the recognition of various stakeholder interests in the restructuring of insolvent corporations, drawing on the work of debt collection, rehabilitation, and enterprise theorists. The framework recognizes all investments at risk in an insolvent firm, including equitable investments such as workers' human capital investments, which are greater than the amount suggested by their fixed capital claims. It proposes a means of assigning a monetary value to equitable claims. It also suggests principles for the reconciliation of creditors' rights and judicial recognition of the public interest that are based on a clearer definition of the interests at stake and the priority accorded those interests under insolvency law. A focus solely on creditor or shareholder wealth maximization needs to be recast, with the emphasis placed on enterprise value maximization and an accompanying recognition of fiduciary obligation to creditors and other stakeholders. Chapter 4 examines the current exercise of the courts' discretion under the CCAA, including recognition of the public interest. It addresses the issue of whether the courts are engaged in purposive interpretation or judicial overreach. The chapter also analyses the contribu-

8 Introduction tions of the case-managed process under the CCAA and the role of court-appointed officers. Chapters 5 to 8 then examine four key restructuring cases: Algoma Steel, Anvil Range, Canadian Red Cross, and Canadian Airlines. They track developments of judicial notions of the public interest and offer insight into how this case law furthers the framework advanced in Chapter 3. While three of these cases are from Ontario and one from Alberta, they all had national implications, involving cooperation from multiple courts and regulatory authorities. These novel cases are the leading Canadian cases in development of public interest notions, and they illustrate a helpful trend in the evolution of restructuring law. Chapter 9 draws lessons from four countries with mature insolvency regimes: the United States, France, Germany, and the United Kingdom. This book does not attempt to replicate a rich legal scholarship of international comparative analysis. Rather, the focus is on the narrow question of how comparative restructuring schemes take account of the issues and themes raised in this discussion, specifically, the public policy recognition of the value of workout schemes, notions of enterprise value maximization, and recognition of stakeholder interests in the insolvent firm. Internationally, different regimes have attempted to accommodate various interests through a variety of approaches. While the resulting schemes vary somewhat in their objectives, they reflect a trend towards introducing policy instruments that afford a greater balancing of the interests affected in corporate insolvency. If one assumes that legal regimes tend to converge towards optimal outcomes, this trend towards greater balancing supports the argument advanced in this book. Canada's insolvency regime measures successfully in comparison with these foreign regimes, the CCAA providing an optimal balance of flexibility and certainty in aiding parties to the restructuring process. Chapter 10 concludes by reviewing the scope and potential for future developments of the public interest model. It draws a link between current judicial reasoning and the theoretical underpinnings of insolvency law and explores potential developments with respect to other aspects of corporate governance, including expanding legal duties of directors, the role of environmental liability in corporate restructuring, and concerns about public interest in cross-border insolvency proceedings. The chapter offers a summary of potential avenues for obtaining participation and/or decision rights for stakeholders seeking to advance their interests in insolvency workouts. The current

Introduction 9

federal parliamentary review of the CCAA and the Bankruptcy and Insolvency Act raises important questions with respect to the hierarchy and balancing of interests implicated in a firm's financial distress. It also highlights the inherent tension in a public law regime that governs what are largely private negotiations. It should be noted at the outset that the scope of this book is limited to the restructuring of insolvent corporations. But the principles invoked can (and should) be applied to other areas of corporate law, such as mergers, hostile takeovers, or the restructuring of financially healthy corporations, in future research. Moreover, public interest plays a role in consumer or personal bankruptcy law, integrally linked to corporate insolvency because of the community interest in a firm's financial distress and the spin-off economic adjustment effects of firm failure. It is important to bear in mind the growing scholarship on the broader policy implications of a public interest model for consumer bankruptcy.6 One study showed that in the period 1992-4, 28 per cent of all consumer bankruptcies occurred because of job loss or income reduction.7 While corporate restructuring should only occur where there is potential for successfully enhancing value through a viable business plan, workers and other stakeholders have important informational and human capital to contribute to both the negotiation process for the development of a plan and the successful turnaround of the restructured corporation. The restructuring process must develop incentives for such participation.

1 The Existing Regime for Restructuring Insolvent Corporations

The word bankruptcy is derived from the Italian banca rotta when medieval merchants would have their marketplace benches broken if they defaulted on payments. Restructuring suggests that debtors' benches should be fixed, not broken, and that creditors should be treated fairly, recognizing their diversity of interests. Karen Gross1 Creditor! e lavoratori insiemi possono riparere il banco, per aumentare il suo valore.2

Insolvency systems are an indispensable component of commercial economies, and the particular system adopted by a jurisdiction usually reflects economic and societal choices regarding how to address firm failure.3 Insolvency law thus forms an important part of the corporate governance regime, because it regulates governance of an insolvent corporation during the key period of decision making about its future. This chapter examines the historical origins of Canada's restructuring regime in order to situate the current theoretical debate and to gain insight into the underlying purposes of Canadian insolvency law. It provides an overview of the current scheme for workouts of insolvent corporations and the role of the judiciary in developing notions of the public interest. At the heart of Canada's insolvency law lies an early twentiethcentury statute. The Companies' Creditors Arrangement Act (CCAA), en-

The Existing Regime for Restructuring Insolvent Corporations 11

acted in 1933, acknowledged broad interests in an insolvency but left unresolved how these interests should be recognized. The Act, moreover, essentially fell into disuse, until debtor corporations and secured creditors discovered it as a valuable restructuring tool in the late 1980s. Recently, the courts have recognized the interests of non-traditional creditors or stakeholders, utilizing terms such as the 'public interest' or 'social stakeholders.' This re-emergence in the past decade of recognition of interests broader than traditional creditor and shareholder interests is an important development in the law. But it raises the questions of how the public interest is to be defined and measured, and what the scope of judicial decision making should be. Judicial consideration of public interest has also engendered criticism from some senior creditors and their legal counsel. There was a high level of support for decision making that protected secured creditor interests to the exclusion of almost all other interests, and attempts to accommodate broader interests have been construed by some as judicial overreach. These issues are discussed in the chapters that follow. Origins of the Canadian Restructuring Regime The historical origins of the Canadian insolvency regime offer insight into the original purposes of restructuring legislation. The legislation of 1933 anticipated the importance of a scheme that recognizes multiple investments in the corporation and offers a mechanism to avoid premature liquidation, in which the insolvent corporation is liquidated even though the value that would accrue to satisfy creditors would be greater if the firm were to continue in operation. The original legislation endorsed the notion that it was in the public interest to afford corporations the opportunity to reorganize as an alternative to liquidation. The historical perspective also provides a foundation on which to explore the current theoretical debate about the underpinnings and efficacy of restructuring statutes. The enactment of the CCA A in 1933 must be understood in the context of previous bankruptcy legislation.4 A federal Bankruptcy Act had been enacted in 1919 after an almost forty-year gap in national bankruptcy legislation.5 The impetus for this legislation was a wave of commercial failures, following which creditor groups lobbied for national consistency in the administration of bankrupt estates. This legislation was thus a product of private initiative, not public policy, driven by creditors who wanted to ensure that where they worked out ar-

12 Creditor Rights and the Public Interest

rangements with debtor companies, they had the ability to bind minority and dissenting creditors through court orders.6 The 1919 bankruptcy legislation applied, for the first time, to both companies and individuals, and allowed debtors to make compromise proposals prior to bankruptcy, subject to creditor approval and court sanction. A formal mechanism to allow debtors to negotiate a proposal with creditors and the availability of bankruptcy discharge meant that creditors were able to preserve, where possible, the companies as future debtors. However, the effectiveness of this early legislation was undermined: it did not bind secured creditors, who could defeat a proposal by moving to enforce their claims.7 The rehabilitation provisions of the Bankruptcy Act received little scrutiny at the time, the focus being on the efficient administration and liquidation of estates and the forgiveness/punishment role of bankruptcy.8 Amendments enacted in 1923 in response to abuses of debtors and unqualified trustees disallowed proposals for restructuring or compromise before bankruptcy.9 Given the difficulty of reviving a company once it is bankrupt, the amendments resulted in defeat of almost all efforts to restructure financially distressed companies, leading in turn to a number of premature liquidations. By 1933, the Bankruptcy Act and the Winding Up Act essentially provided only for liquidation of a company under a trustee in bankruptcy or a liquidator.10 Yet growing capitalization and concentration of wealth in existing enterprises meant that when a firm experienced financial difficulty, the effects of dissolution of the company were economically more important than they had been in previous years. While the drive for legislative change came from debtor corporations seeking a means to restructure prior to bankruptcy, it was also recognized that firm failure affected not only the owners of the company, but creditors and employees as well. Thus the CCAA was introduced to facilitate compromises and arrangements between companies and their creditors. In introducing the CCAA in 1933, Secretary of State C.H. Cahan noted that the limited mechanisms under existing statutes inevitably resulted in the entire disruption of the corporation, loss of goodwill, and sale of assets on a discounted basis.11 There had been no means by which creditors could reach an amicable settlement in such a way as to permit the company to continue in business through reorganization. The Act was introduced because of the 'prevailing commercial and industrial depression' and was intended to promote adoption of a

The Existing Regime for Restructuring Insolvent Corporations 13

method by which the courts could supervise arrangements between creditors and debtor corporations without the improvident sale of assets of the firm. The legislation was based on the British Companies Act of 1929, which provided for compromises with creditors, setting out value amounts of support required before the courts would endorse a plan.12 Interestingly, the enactment of the CCAA parallels the 1933-4 revisions to U.S. bankruptcy legislation that codified large-scale corporate reorganization for the first time. (The U.S. courts had, for almost half a century, used the common law concept of equity receiverships to allow for the restructuring of insolvent railway companies.)13 References to reform of U.S. bankruptcy law are absent from the Canadian legislative debates. But in the United States, as in Canada, the impetus for reform came largely from credit industry organizations that lobbied aggressively for an enhanced debt collection structure. Support for restructuring measures was part of the compromise between pro-creditor and pro-debtor interests that legislators on both sides of the border were instrumental in effecting. The Canadian government was careful not to encroach on provincial jurisdiction and the 1933 legislation did not address share reorganizations or shareholder votes. The court was empowered, however, to hear applications proceeding conjointly under the CCAA and provincial corporations law, in order to facilitate compromises and arrangements. Creditors were to be grouped in classes having the 'same interest/ to allow them to decide among themselves the terms of compromise of their interests.14 One of the express purposes of the legislation was to provide a mechanism to bind both secured and unsecured creditors, provision for which was lacking under pre-existing bankruptcy legislation. The original CCAA bill was widely circulated throughout Canada in advance of its introduction and it passed speedily through Parliament. The House of Commons Debates are scanty and no minutes were recorded for the proceedings of the Standing Committee on Banking and Commerce.15 Indication of an awareness of the public interest involved is more prominent in the Senate Debates on the CCAA. The Honourable Arthur Meighen, in presenting the government's bill, said: 'the depression has brought almost innumerable companies to the point where some arrangement is necessary in the interest of the company; in the interests of employees, - because the bankruptcy of the company would throw the employees on the street, - and in the interest of

14 Creditor Rights and the Public Interest

security holders, who may decide that it is much better to make some sacrifice than run the risk of losing all in the general debacle of bankruptcy.'16 Thus, as early as 1933, legislators recognized the harm caused by loss of investments, including employment and credit losses in the firm. Unsecured trade creditors initially viewed the CCAA as inadequate to protect their interests, because of the amount of control debtor corporations were able to exercise in the restructuring process, and a bill introduced in 1938 sought to repeal the legislation.17 But the CCAA was not repealed, and debate continued sporadically with respect to the amount of control exercised by debtor companies. In 1953, the CCAA was amended to restrict its application to companies that had issued bonds or debentures under a trust, and thus to limit access to its use to larger, publicly held companies - the rationale being that there was less opportunity for debtor corporations to act entirely selfinterestedly in the CCAA process when they were publicly held.18 During this period, use of the CCAA appears to have focused on reorganization of companies with complicated public debt structures, where there was an indenture trustee to monitor or control the corporation. The CCAA was originally enacted to provide a mechanism by which insolvent companies could avoid bankruptcy through 'workable and equitable' restructuring plans.19 The underlying notion was that creditors who received only the liquidation value of the corporation received considerably less than the value of a going concern. As a consequence, plans of arrangement or compromise sought to allot amounts to creditors that at least preserved the liquidation value of their claim. Legislators were cognizant of the fact that the power to bind dissenting creditors should not be used to confiscate their legitimate claims. An effective reorganization scheme would assist in preserving goingconcern value of insolvent companies that had a good chance of survival, prevent the loss of many jobs, and help ensure that investors and creditors were not deprived of their claims or the opportunity to share in the value of future activities of the company. Yet, from 1933 to 1947 the CCAA was rarely invoked. Only seven judgments dealt with or referred to the CCAA in that period, and none discussed the merits of restructuring plans.20 There was some early public policy recognition of the value of workouts: in 1947, the Quebec Court of Appeal held that the purpose of the legislation was remedial and rehabilitative, and that the courts' discretionary power was

The Existing Regime for Restructuring Insolvent Corporations 15

aimed at helping to effect a successful restoration of the business enterprise if the requisite creditor approvals of a plan of arrangement had been obtained.21 But in contrast to the United States, where there was a rich scholarship documenting the development of early reorganization law, in Canada, little study was made of the policy implications of the CCAA.22 Stanley Edwards, in the only scholarly published article on the CCAA in the decade after its enactment, did, however, recognize the public interest implicated in the restructuring legislation: 'Reorganization may give to those who have a financial stake in the company an opportunity to salvage its intangible assets. To accomplish this they must ordinarily give up some of their nominal rights, in order to keep the enterprise going until business is better or defects in management can be remedied ... it is in the interests of the public to continue the enterprise ... especially if it employs large numbers of workers who would be thrown out of work by its liquidation, ... and this (public interest) is undoubtedly a factor which the court would wish to consider in deciding whether to sanction a plan under the CCAA.'23 Edwards noted that consumer, investor, and employee interests, as well as the public interest more generally, were concerned with the reorganization of companies, and that these interests should be borne in mind by those supervising the restructuring. Successful implementation of the legislation required that parties recognize as much as possible the nominal legal rights of classes to participate in the value generated if the reorganization were successful. This early commentary supports my assertion that the CCAA was enacted to facilitate restructuring plans in such a way as to recognize the interests of workers, trade suppliers, and communities. There is also historical support for the view that decision making with respect to the future of the corporation is enhanced if the governance decisions take into consideration the interests of all those with investments at risk. The court, in rendering an informed and independent judgment, was to consider all points that could possibly affect the decision, because restructuring involved the public generally and 'it would be inauspicious for the review to be confined to questions raised by creditors and shareholders at the hearing.'24 Informed judgment was to include adequate data as to what factors of public interest are involved, an understanding of the conflicts of interest among those with a stake in the corporation, valuation of the assets if they were to be liquidated, and estimate of future probable earnings of a reorga-

16 Creditor Rights and the Public Interest

nized company, in order to fully protect the interests of the public, employees, minority creditors, senior secured creditors, and shareholders. Restructuring legislation, while creditor driven in its origins under the Bankruptcy Act, was by the time that the CCAA was enacted clearly concerned with interests broader than those of shareholders and traditional creditors. The legislative history of the CCAA illustrates that employment and other economic effects on communities have from its inception been valid considerations. The regime has historically supported in broad strokes the importance of productive use of human capital and consideration of workers' interests. However, there is no historical direction as to how this goal was to be accomplished, other than an indication that it was to be part of judicial decision making. There is nothing in the early cases to suggest that workers were to be given greater voice. Rather, the court was to consider stakeholder interests, even though they were not present before it. The CCAA essentially fell into disuse for half a century, and notwithstanding its existence, Canada's insolvency system historically favoured liquidation. Only in the past fifteen years has there been a shift towards a regime that encourages restructuring. The renewed interest in the CCAA was likely driven by a need to find alternatives to premature liquidation. With the growth in debt financing, failures from leveraged buyouts and fluctuating products markets, and competition for capital in an increasingly global market, the size and impact of firm failure was unprecedented. When the Bankruptcy and Insolvency Act (BIA) was amended in 1992 to facilitate restructuring of insolvent small and medium-sized enterprises, there was some debate regarding the necessity of having two restructuring statutes.25 The CCAA was left intact at that time in order to provide a period in which to assess whether the BIA proposal provisions would be effective in replicating the restructuring mechanisms under the CCAA. Similarly, the 1997 amendments to bankruptcy and insolvency legislation did not include repeal of the CCAA. Rather, the CCAA was amended to make it more accessible, to restrict its use to larger companies, and to conform with provisions of the BIA. In the intervening period, there has been considerable discussion of insolvency and bankruptcy law. Much of this theoretical debate arises in the context of U.S. bankruptcy proceedings under Chapter 11 of the U.S. Bankruptcy Code26 and centres on both the policy objectives and policy instruments of value in the governance of financially distressed

The Existing Regime for Restructuring Insolvent Corporations 17

corporations. However, an overview of the current Canadian restructuring regime and the issues raised by the 'public interest' are key to understanding the theoretical debate reviewed in chapter 2. Overview of the Canadian Insolvency Restructuring Regime The first means by which an insolvent corporation can restructure its affairs is through a private workout. This is possible if there are few creditors or it is a closely held company. Use of a private workout does not necessarily signal to consumers or even trade suppliers that the corporation is in difficulty, and it may facilitate the retention of key employees and distributors who might otherwise begin diversifying their risk by seeking employment or contracts elsewhere. Generally, private workouts are cheaper and faster than court-supervised processes, in part, precisely because there are fewer creditors and thus fewer transaction costs and collective action problems in the negotiations. However, many cases of corporate insolvency involve hundreds and sometimes thousands of creditors. A private workout is not possible in these circumstances. Given that creditors are not prevented from seeking to enforce their claims during negotiation for a private workout, debtor corporations often seek the protection of court-supervised processes. The critical Canadian statutes governing insolvency and bankruptcy are the Bankruptcy and Insolvency Act and the Companies' Creditors Arrangements Act.27 The BIA is aimed at bringing uniformity to the administration and liquidation of bankrupt estates in Canada. The underlying principle of the bankruptcy regime is that creditors should control administration of the assets of the corporation that has been placed into bankruptcy, because liquidation is for their almost exclusive benefit and they are in the optimal position to ensure that their best interests are met. The BIA also establishes a hierarchy for the satisfaction of claims, influenced in part by companion statutes such as the Bank Act,2e The BIA and CCAA provide separate but complementary regimes for companies to make proposals or plans of arrangement or compromise to structure their affairs to the satisfaction of creditors and with a view to becoming economically viable. Some corporations can choose which regime they will utilize, but the CCAA specifies that it applies only where there are claims against the debtor corporation or affiliated debtor companies in an amount exceeding $5 million.29 This indicates a legislative intent to restrict access to the

18 Creditor Rights and the Public Interest

CCAA to larger or more complex restructurings and limits somewhat the ability to 'forum shop.' While the restructuring provisions of the BIA are generally aimed at small to medium-sized enterprises, the BIA is nonetheless available to larger debtors that find the stability and specificity of its proposal scheme attractive. A third, less commonly used, means of restructuring is offered by the Canada Business Corporations Act (CBCA) arrangement provisions.30 The principal reason for using the CBCA or other corporations statutes is to preserve equity for shareholders. To use the BIA or CCAA, the corporation must be insolvent, and thus little or no equity remains. In contrast, the arrangement provisions of the CBCA require the corporation to be solvent, and they can be used to try to preserve shareholder equity as well as value for creditors. While some concern has been expressed about employing corporations statutes in restructuring insolvent corporations, the courts have endorsed such usage.31 For example, in Dome Petroleum, Dome was clearly insolvent, yet the proposed arrangement required amalgamations and debt exchanges, neither easily provided for under the CCAA, even if the application had been brought conjointly with a CBCA application.32 Amoco Acquisitions, a solvent corporation that was the applicant in the proceedings, sought and received a declaration from the Alberta Court of Queen's Bench that its proposed arrangement was an arrangement pursuant to the CBCA and that the court had jurisdiction. It then proceeded to secure the support of creditors and shareholders, and the endorsement of the court, to amalgamate with Dome and several other subsidiaries. The court facilitated the plan of arrangement by liberally interpreting the arrangement provisions of the CBCA. Often parties need to utilize more than one statute in a workout. Amendments to share structure, for example, must be effected under arrangement proceedings of the applicable corporations legislation, as there are no such provisions under either the BIA or the CCAA.33 Moreover, where there are public shareholders, the courts have sanctioned mechanisms such as special committees of independent directors, hired specialized expertise, and court-ordered meetings of public shareholders to assist in determining the fairness of a proposed arrangement.34 A key component of the Canadian restructuring scheme is the integration of federal tax law facilitating restructuring. A workout can, under either the BIA or the CCAA, involve conversion of debt to equity through mechanisms such as issuing distressed preferred shares, which qualify for special treatment for five years under the Income Tax

The Existing Regime for Restructuring Insolvent Corporations 19s

19

Act.35 Dividends received on the shares are tax deductible in computing taxable income, thus providing a less expensive means of financing a restructuring. It allows insolvent firms to offer incentives to investors, including existing creditors, who might not otherwise be willing to provide additional financing. The courts have held that the issuance of such shares facilitates restructuring of the debtor corporation by exchanging debt for equity and reducing financing costs.36 The objective of corporate restructuring systems is to preserve the corporation as a going concern, notwithstanding the fact that it is financially distressed, if it can potentially become viable. By placing a stay on the ability of creditors to enforce their claims for a limited period, creditors cannot force the corporation into bankruptcy. The quid pro quo of the stay is that any proposal, plan of arrangement, or compromise must have the support of the majority of creditors in an amount of two-thirds of the value of claims in each class in order to receive the sanction of the court. Amendments to the BIA and CCAA since 1992 have been aimed in part at enhancing the fairness and efficiency of the system. In introducing the first major amendments to bankruptcy legislation since the 1940s, the government expressly stated that its objectives were to better protect all market-place participants, consumers, workers, and companies by better balancing debtor and creditor rights; by making rehabilitation rather than liquidation the focus of the legislation; by helping viable businesses better survive short-term downturns; by preserving jobs; and by providing greater protection to unpaid suppliers and wage earners.37 Proposals under the BIA The highly codified workout provisions of the BIA provide the context for the debate regarding the CCAA. The Bankruptcy and Insolvency Act, as the core legislation governing insolvency and bankruptcy, affords smaller companies without complex ownership or debt arrangements a mechanism to develop proposals to restructure or compromise debts in order to avoid bankruptcy. Use of the BIA proposal provisions has increased, particularly since the 1992 amendments that allowed for proposals to bind secured creditors. In 1994, there were 743 commercial restructuring proposals under the BIA, compared with 11,810 business bankruptcies.38 By 2001, over 2,600 proposals were filed, compared with 10,400 business bankruptcies nationally, the result of legislative amendments stressing the survival of troubled companies over

20 Creditor Rights and the Public Interest

liquidation.39 The federal Superintendent of Bankruptcy exercises broad oversight over the BIA; however, in respect of BIA proposals, it is the trustee in bankruptcy as the court-appointed officer and the court itself that exercise the oversight of the debtor's proposal process. The proposal provisions under the BIA are highly rule driven, with most of the standards and process for developing a proposal specified by the statute. As a result, the BIA can be less flexible than the CCAA, which in large measure has had its standards set by judicial decision making. However, for the financially troubled small business or corporation, the certainty of the statutory proposal provisions can reduce the cost of negotiations with creditors and of numerous court appearances. Both statutory schemes thus play an important role in the restructuring of insolvent businesses. When a corporation becomes insolvent, there are remedies available to creditors. The insolvency scheme provides that secured creditors can privately enforce their claims by meeting statutory and common law requirements of demand, reasonable notice, and notice of intention to enforce security.40 Once these are met, the creditor can privately appoint or seek a court-appointed receiver to realize on its claims. A creditor falls within the scope of the BIA enforcement provisions if the debtor is 'insolvent' within the meaning of the statute and the collateral being enforced against by the secured creditor constitutes all or substantially all of the debtor's assets. The BIA defines insolvency as debts exceeding $1,000, and an 'insolvent person' one who is unable to meet obligations or has ceased paying them in the ordinary course of business as they generally become due, or where the assets if disposed of at a fair valuation would not be sufficient to enable payment for all obligations.41 Insolvency and bankruptcy law is aimed at allocating decision and control rights in the financially distressed corporation to ensure optimal use of the assets, whether the ultimate disposition is continuation of the business, sale as a going concern, liquidation, or some combination of these strategies.42 As a result, in addition to its debt collection mechanism, the BIA also provides a scheme for commercial proposals, in order to allow an insolvent company an opportunity to restructure its affairs and become financially viable. As with the CCAA process, the proposal process allows a brief reprieve in which the status quo is maintained and creditors' realization rights are temporarily suspended. 'Proposal' is defined in the BIA as including a proposal for a composition, where creditors agree to accept less than full repayment or an

The Existing Regime for Restructuring Insolvent Corporations 21

extension of time, and/or a scheme of arrangement in terms of alteration of debt and equity structure.43 Corporate officers retain control of the corporation's assets and operations, and the trustee that assists with development of the proposal acts in a monitoring and advisory capacity, as opposed to assuming control of the company. An insolvent business or corporation can obtain a stay of proceedings against creditors for a limited period of time, in order to allow the company to develop a proposal of its debts to creditors. Filing either a proposal or a notice of intention to make a proposal gives rise to an automatic stay of thirty days.44 The fact that the stay is automatic means that the debtor corporation does not incur the cost of seeking court approval and does not require the support of creditors at the outset of the process. During the stay period, the debtor corporation has an obligation to work in good faith and with due diligence to formulate a proposal.45 A debtor corporation may make a proposal to creditors either before or after bankruptcy. The inability of creditors to make proposals is a negative feature of the BIA scheme. In contrast, the CCAA allows creditors to develop and propose plans of arrangement or compromise, thus facilitating collaboration of stakeholders in devising a viable workout plan.46 An insolvent business must submit its proposal to a licensed trustee in bankruptcy. The trustee files the proposal and a cash-flow statement, prepared and signed by both the debtor corporation and the trustee, with the Official Receiver. The trustee is obligated to review and report on the reasonableness of the cash-flow statement, and must generally make this statement available to creditors on request. The trustee is responsible for convening a meeting of creditors within twenty-one days of filing the proposal. Similarly, before filing a notice of intention to file a proposal with the Official Receiver, the debtor corporation must have the written consent of a licensed trustee who has agreed to act in the proposal. Once a notice of intention is given, the trustee must file the cash-flow statement and assessment of reasonableness within ten days. Failure to do so results in the debtor company being deemed to have made an assignment in bankruptcy.47 The trustee advises the debtor in the preparation of the proposal, monitors the debtor's activities, and reports to the court and creditors periodically. While the trustee has a statutorily prescribed duty to assist the debtor in developing a proposal, it must be careful to take into account the interests of both the debtor corporation and the general body of creditors. The courts have held that, in the context of a pro-

22 Creditor Rights and the Public Interest

posal under the BIA, the trustee is not an agent of the debtor corporation but rather an officer of the court and must impartially represent and protect the interests of creditors.48 If the proposal does not attract the required level of creditor support, the vote defeating it in theory results in automatic bankruptcy.49 Practically speaking, however, where a meeting of creditors is held and there is general interest in finding an acceptable proposal, a 'straw vote' is taken of the classes of creditors, and if the requisite support does not exist, the parties attempt some renegotiation of the proposal. A failed 'official vote' thus does not automatically result in an assignment in bankruptcy. If a class or classes of secured creditors reject the proposal, there is no deemed bankruptcy; rather, the secured creditors of that class are free to exercise their rights under their security without further regard to the proposal proceeding. Although the proposal does not require the approval of secured creditors, given that they hold first rights to the property of the corporation, realistically, their approval is necessary because enforcement of security by significant secured creditors will render a proposal unworkable. As a result, proposal approval is often expressly conditional on acceptance of the proposal by all classes of secured creditors. In respect of a bankrupt company, the inspectors must approve a proposal, as the court's approval operates to annul the bankruptcy and to revest the bankrupt property in the debtor or any other party the proposal and/or the court directs.50 While the initial stay is automatic, the court plays an important supervisory role throughout the proposal proceedings. A trustee can bring a motion for directions on numerous matters. The debtor corporation can seek extension of the initial stay period from the court in up to forty-five-day increments to a maximum of six months in total. The court, in exercising its discretion to grant an extension, must be satisfied that the insolvent corporation has acted in good faith and with due diligence; that it would likely be able to make a proposal if an extension is granted; and that no creditor would be materially prejudiced by the granting of an extension.51 The court does not have the flexibility available under the CCAA to grant longer or more flexible stay periods. The tight time frame and maximum amount of stay period means that the debtor corporation must act expeditiously to devise a proposal that is acceptable to creditors. A disadvantage is that the rigid time frame can result in negotiations with only the largest

The Existing Regime for Restructuring Insolvent Corporations 23

creditors, in order to satisfy the minimum statutory requirement for creditor support. Once creditors have accepted a proposal, the trustee must apply to the court for approval within a specified time, following notice and reporting requirements.52 It is here that the court's role is particularly important, because there are a series of highly codified requirements with respect to the content of the proposal. The court must be satisfied that the proposal meets the statutory requirements; it must also consider whether the proposal is in the interests of the general body of creditors and the public interest in preserving the bankruptcy process.53 The approved proposal effectively becomes a contract between the company and its creditors, breach of which will give rise to bankruptcy.54 The effect of court approval is to make the proposal binding on all parties the proposal is aimed at, including the unsecured creditors that voted against it and the secured creditors that voted against the proposal but that were in a class that voted in favour in the requisite amounts. Given that the proposal alters the rights of creditors, the courts have held that it will ensure the provisions of the BIA have been strictly complied with.55 For example, the BIA specifies that the court shall not approve the proposal where the assets of the corporation are not of a value equal to fifty cents on the dollar of the debtor's unsecured liabilities, although the court may provide for a lower percentage where it is satisfied that the debtor did not cause the deficiency.56 The court must also be satisfied that the proposal provides for payment of preferred claims under section 136 in priority to classes of ordinary creditors, and for payment of all fees and expenses of the trustee in respect of the proposal proceedings.57 The proposal must also provide for payment of claims under the federal Income Tax Act, the Canada Pension Plan, the Employment Insurance Act, and similar provincial legislation, unless the Crown has otherwise consented.58 Even where the court has approved a proposal, it can have a continuing supervisory role in some instances. If the debtor defaults on the requirements of the proposal, discovery is made of a fraud on the court in the original approval process, or if the proposal cannot continue without injustice or undue delay, the court may annul a proposal.5' While the proposal provisions under the BIA afford an opportunity for expeditious development and approval of a viable business plan for an insolvent corporation, its rule-driven features reduce flexibility

24 Creditor Rights and the Public Interest

in the workout process. This can be a disadvantage where there are diverse types of claims or a complex debt structure. However, the proposal provisions are generally viewed as less costly, given the need for fewer court appearances and the certainty imposed in regard to numerous features required of any proposal. This makes the BIA scheme attractive for small to medium-sized businesses or for large corporations where the claims are relatively uncomplicated. Creditors sometimes also prefer that the debtor corporation pursue this route, because of the tight time frames and the certainty that there will either be a proposal or a bankruptcy within six months. The definition of creditor under the BIA is broad enough to encompass numerous interests, including the claims of contingent creditors. It does not, however, recognize the interests of stakeholders who do not have direct capital claims on the assets of the corporation, an issue discussed in chapter 3. Judicial oversight is key to ensuring that creditors' rights are impaired as little as possible during the period that their ability to realize on their claims is suspended. Given its rule-driven features, the BIA does not pose the same kinds of challenges as the CCAA in discerning the public interest in the workout process. Plans of Arrangement or Compromise under the CCAA The CCAA is a companion statute to the BIA, aimed solely at providing a scheme for the restructuring of insolvent corporations. As under the BIA, restructuring can include amending terms of existing debt, such as rescheduling principal repayment, extending maturity dates, altering interest rates, or forgoing a portion of the interest or principal owed by the debtor corporation. It also allows the corporation to restructure in such a manner as to allow parties to participate, on a proportional basis, in the value generated by the company as a result of the reorganization. Prior to 1992, the court could not bind secured creditors under the BIA. Under the provisions of the CCAA, however, the debtor corporation could receive a court-ordered stay of secured creditors' claims, making this an attractive forum in which to seek restructuring in the late 1980s and early '90s. Whereas the BIA is largely rule driven, containing approximately three hundred subsections and extensive and detailed requirements for commercial proposals, the CCAA is a short statute of only twenty-five sections. The CCAA thus permits a wider range of restructuring options and allows parties to fashion a process that meets their particular needs, subject to the court's

The Existing Regime for Restructuring Insolvent Corporations 25

approval. Application of the CCAA has evolved through judicial interpretation, and the courts have held that its efficacy is that it is a flexible instrument for the restructuring of insolvent companies.60 The court provides judicial oversight of the restructuring process, a role that creates particular challenges in discerning and balancing the rights of creditors with the 'public interest.' The courts have often specified that the purpose of the statutory regime established by the CCAA is to facilitate compromises and arrangements between companies and their creditors in order to allow the corporation to continue to operate for the benefit of all stakeholders.61 In interpreting the statute, the courts have been concerned with both the protection of creditors' rights and the public interest impact of their decisions. For example, the British Columbia Court of Appeal in Hongkong Bank of Canada v. Chef Ready Foods held that there are devastating social and economic effects of bankruptcy and liquidation: shareholder investments are destroyed, unemployment creates hardships on workers, and creditors recover little of their claims.62 The definition of creditor is reasonably broad and mirrors somewhat the language employed in the BIA. 'Secured creditor' is defined in the CCAA as a holder of a mortgage, hypothec, pledge, charge, lien or privilege, assignment, transfer of property of a debtor company as security for indebtedness, or a holder of a bond secured by any of these, and any trustee under any trust deed or instrument securing any such bonds.63 'Unsecured creditor' is defined as any creditor of the company that is not a secured creditor, and a trustee for the holders of any unsecured bonds issued under a trust deed or other such instrument.64 Thus, the statutory definitions of creditor are very expansive, and have been interpreted to include tort claimants as contingent creditors. Either the debtor corporation or a creditor can make the initial application for a stay or propose a plan of compromise or arrangement.65 The purpose of a CCAA stay order is to maintain the status quo for a specified period of time so that a proposed plan can be developed and presented to creditors for their consideration.66 This stay is by court order and not automatic. Similarly, claims against directors are not automatically stayed; however, such stays are routinely set out in the initial order. The statute allows the insolvent corporation to carry on business in a manner that allows time to undertake discussions with creditors, to attract outside investment, and that enables the company to prepare, file, and seek approval from creditors, and ultimately the

26 Creditor Rights and the Public Interest

court, for a proposed plan. The initial stay is for thirty days. The court has held that the granting of any additional stay of proceedings will be based on the court's assessment of whether the debtor company has worked diligently and in good faith towards the development of a plan.67 Generally, approval of the creditors is not a prerequisite for extension of a stay; rather, the courts have held that the extension is for the benefit of all the company's stakeholders, not just the creditors.68 Under the CCAA, extensions on the initial stay are not limited to fixed periods or a fixed maximum, although the courts have made it clear that they expect an expeditious process. For example, in Olympia and York, the complex nature of real estate holdings and debt structure across multiple jurisdictions required a fourteen-month process to develop an appropriate plan of arrangement, a process that would not have been possible under the more restrictive BL4.69 Under the CCAA, the court appoints a 'monitor,' who may or may not perform a role similar to that of a trustee under proposal provisions of the BIA, depending on the scope of the court's order. The monitor is almost always an insolvency professional with accounting or turnaround expertise, and is represented by legal counsel in the CCAA proceedings. The court has discretion to direct the monitor to perform duties such as acting as liaison with the creditors and providing an opinion on the debtor corporation's ability to meet the requirements of a revised business plan. Appointment of a monitor had become accepted practice in CCAA applications, and it became mandatory with the 1997 statutory amendments.70 The role of the monitor is now defined under the CCAA and includes having access to the company's records and property to the extent necessary to assess the company's financial affairs. The monitor must also file a report with the court at least seven days prior to any creditors' meeting, or at such times as the court directs. This report sets out the state of the corporation's business and financial affairs and any material adverse change in projected cash flow or financial circumstances. The monitor advises creditors of the filing of the report and carries out any additional functions that the court may direct. These duties may include assisting the corporation in developing a plan of arrangement or facilitating negotiations with creditors. Typically, the directors and officers of the corporation remain responsible for its assets and operations and try to craft a plan that is acceptable to creditors. This may involve compromising the debt, exchanging equity for debt, issuance

The Existing Regime for Restructuring Insolvent Corporations

27

of new shares, or shifts in control of the company. The monitor, as an officer of the court, ensures that they do nothing that would unnecessarily deplete the resources available to satisfy creditors' claims. Decision making by corporate directors and officers is subject to closer scrutiny by creditors once the corporation files a CCAA application. The plan developed can also compromise claims against the directors that arose before the CCAA proceeding.71 This is to encourage directors to remain during the workout process, so that their knowledge and expertise can be utilized in devising a viable plan. The court's role is to ensure that the statutory requirements have been met in terms of creditor approval, and that the proposal is 'fair and reasonable' with regard to all the circumstances. Courts have reinforced the notion that the CCAA provides a structured environment for the negotiation of compromises and arrangements between a debtor corporation and its creditors for the benefit of both.72 The underlying premise is that it is better for the company, and for its shareholders, employees, and creditors, to allow the company to operate in such a manner that it can meet its obligations, than to liquidate it. As the Cour superieure du Quebec recently observed in Hydrogenal Inc., the courts have consistently held that the CCAA should be interpreted in a fair, large, and liberal manner, with the court considering the equities in each case.73 While the CCAA does not have an express-purpose clause, the courts have been consistent in their findings regarding both the debt collection and rehabilitative nature of the statute.74 Although there were two major amendments to the statute in the 1990s, legislators have not interfered with this interpretation. It is thus safe to infer that the goals articulated by the courts are public policy. The CCAA is a vitally important part of corporate law. The 1997 amendments requiring a minimum debt before parties can make an application under the Act has not resulted in a decline in the number of applications, attesting to the significance of the statutory scheme. Although there are no national statistics on the number of CCAA applications, they comprise a substantial portion of the time and resources of Canadian courts and involve hundreds of millions in debt and thousands of creditors and employees. These cases consume considerable judicial resources, which is likely a function both of the size and complexity of the corporations that come before the court and the amount and complexity of the debt arrangements that require restructuring. As will be illustrated in chapters 4 to 8, the court-supervised

28 Creditor Rights and the Public Interest process affords a higher level of scrutiny than private workouts in terms of stakeholder interests, because of the court's requirement that the plan be fair and reasonable. The CCAA gives public policy recognition to the value of restructuring processes, and the crux of its success as a restructuring tool has been the willingness of the courts to interpret the statute in a purposive manner. Mr Justice Tysoe of the British Columbia Supreme Court has observed that the successful reorganization of Quintette Coal was enabled by the flexibility of the CCAA and the court in allowing the parties time to craft a viable plan.75 The regime supports creditors' rights by requiring a minimum threshold of creditor support by majority in number and two-thirds majority in value in a class before the court will sanction the plan. It balances creditors' rights to enforce with an entitlement of shareholders and their agents to devise acceptable viable business plans. The stay provisions facilitate the arrangement of refinancing, the consideration of diverse creditor interests, the time to discern and negotiate with creditors who have both converging and diverging interests, and thus ultimately the ability to achieve broad support for the proposed plan of arrangement or compromise. The lack of codified requirements under the CCAA gives the parties and the court the flexibility to craft constructive and timely workout plans to preserve the business. This plan may include a liquidation under the CCAA, where it allows the parties high asset value realization.76 The Act also gives the court the flexibility required to recognize the interests of a broad range of stakeholders in the negotiations for and approval of restructuring plans. Challenges Posed by Judicial Oversight of the CCAA Notwithstanding the popularity of the CCAA as a restructuring vehicle, concern has been expressed that the courts have engaged inappropriately in excessive judicial activism. This issue is analysed at some length in chapter 4. However, a cursory appreciation of this concern will enable a better understanding of the theoretical debate reviewed in the next chapter regarding policy objectives and instruments in the restructuring of insolvent corporations. The court makes two key determinations under a CCAA application. First is the exercise of its discretion to grant the stay, which raises the issue of whether the statute is a last resort instrument or whether access to the process should be liberally granted. Here, the question is

The Existing Regime for Restructuring Insolvent Corporations 29

whether judicial exercise of this discretion has been uncertain, uneven, or exercised in the interests of the debtor corporation to the unnecessary prejudice of creditors. The second determination involves the sanctioning of a plan of compromise or arrangement, which is less subject to judicial discretion because the statute specifies the amount of creditor support required before the court has jurisdiction to sanction a plan. In the interim period between these orders, the court is called upon to make numerous decisions. For example, the definition of classes of creditors for voting purposes is often crucial to a successful restructuring. Here the issue is whether the courts have developed tests that advantage secured creditors and the debtor to the disadvantage of unsecured creditors, or whether the courts are merely interpreting class in a manner that promotes the statutory objective of facilitating restructuring,77 Similarly, definitions of class raise the question of whether the court has failed to recognize the interests of workers as distinguishable from other unsecured creditors, and whether definition of class acts to diminish recognition of these interests. Given that the debtor proposes the class definitions, and that the parties with smaller claims and fewer resources are not before the court, the issue is whether the court can properly make a determination of such issues. It had earlier been suggested that the exercise of judicial discretion preserving the status quo during the stay period would require the lenders of operating capital to continue lending; however, the CCAA was amended in 1997 to clarify that a stay order does not require the further advance of money or credit.78 The amendments also clarified that the stay did not have the effect of prohibiting a party from requiring immediate payment for any goods, services, or use of leased or licensed property provided after the order is made. But the question of interim financing during the stay period continues to be a hotly contested issue. The statute is silent on the question of debtor-in-possession (DIP) financing, and the courts have made a number of decisions granting such financing over the objection of senior creditors. These issues raise the larger question of whether the courts are engaged in purposive interpretation or judicial overreach, a subject taken up in chapter 4. First, however, we turn to the theoretical underpinnings of the insolvency regime.

2 Current Theoretical Approaches to Insolvency Law

This chapter examines the current theoretical debate regarding the purpose of insolvency and bankruptcy law, including the relevance of public policy or public interest in the context of private commercial law. The focus here is development of a sound conceptual understanding of governance of an insolvent corporation, particularly a corporation that is seeking to restructure its affairs with a view to becoming economically viable. The discussion of debt collection, rehabilitation, and enterprise wealth maximization theories sets the stage for the conceptual framework developed in chapter 3. Many jurisdictions have developed elaborate schemes for the determination of ranking or priority in bankruptcy, as well as companion schemes that afford debtor corporations the opportunity to restructure their affairs and make arrangements with creditors to allow the corporation to remain a going concern. Liquidation and reorganization are two possible outcomes of such schemes. However, a workout strategy can combine elements of both to maximize firm value over time. The legislative scheme adopted can act to facilitate or discourage these outcomes and the variety of arrangements they generate,1 and the interests of various creditors and other stakeholders converge and diverge around them. Most regimes provide for both liquidation and restructuring, because in addition to competing, the availability of these options can be complementary. Adoption of a specific regime may reflect in part the particular society's assessment of the moral blameworthiness or lack thereof of a corporation's financial difficulty. The choices made also reflect not only preferences for liquidation or

Current Theoretical Approaches to Insolvency Law 31

reorganization, but preferences for particular stakeholders because of their economic interests or because they are particularly vulnerable to firm failure. While the focus of this book is on restructuring, corporate workouts must be situated within the broader framework of bankruptcy and liquidation. Liquidation usually involves the sale of assets on a piecemeal or going-concern basis to a third party. Liquidation schemes tend to be straightforward, involving few administrative costs and little public expectation of firm recovery.2 However, inefficiencies are difficult to measure because the potential going-concern value is never realized. Reorganization or restructuring involves a plan in which the assets of the corporation are essentially sold to the creditors and/or other stakeholders through a conversion of debt to equity, compromises of the amount of claims owing or timing of payments, refinancing agreements, or the injection of new equity investment in the firm.3 Such regimes are more costly to administer, but they may result in greater economic recovery for greater numbers of creditors. Restructuring can also result in hybrid arrangements, such as sale or liquidation on a going-concern basis or liquidation of part of the business in order to finance restructuring of the rest of the enterprise. The general premise underlying a restructuring scheme is that where the corporation is worth more as a going concern than it would be if liquidated on a piecemeal basis in terms of satisfying creditors' claims, creditors and other parties should be allowed to negotiate a workout. Restructuring regimes allow parties to craft proposals, plans of arrangement or compromise, reorganizations, schemes of administration, redressements, and other plans.4 All of these terms refer to statutory schemes in mature market economies that set out a procedure for the negotiation of a plan that affords the debtor corporation an opportunity to stay in business in an effort to become economically viable. Most regimes have provisions allowing the temporary suspension of creditors' rights to enforce their claims while the debtor corporation is attempting to devise a restructuring plan, thus avoiding premature liquidation. In many schemes, court-appointed officials monitor, oversee, or actually manage the corporation during this period. Often the court-supervised process assists with the collective action and transaction costs among the firm's diverse creditors, and between creditors and corporate officers, thus ensuring more value is extracted from the firm.5 In this book, the terms 'restructuring,' 'reorganization,' and 'workouts' are used generally to refer to these processes and the issues they

32 Creditor Rights and the Public Interest

raise. When discussing specific legislation, reference is made to the particular statutory terminology and requirements. In Canada, as in most jurisdictions, there is a statutorily enacted hierarchy or priority of claims reflecting the country's normative choices regarding credit principles. First, unsecured creditors, unless given statutory preference, share on a pro rata basis with other unsecured creditors, regardless of when their claims arose.6 Second, if an unsecured loan exists and a creditor later takes security, the later secured creditor's claim takes priority. Third, an initial creditor making a secured loan generally has priority over later secured credit, except where statutes have created specific provisions for security over particular assets. In Canada, purchase money security interests are a good example of this. Thus, whether the insolvent corporation is to be restructured or liquidated on a going-concern or asset basis, the scope of the transactions will depend in large measure on the particular rights and priorities of creditors and others with interests in the corporation. Governments in many jurisdictions have concluded that it is important to provide an alternative to liquidation and a means by which corporations can work out their affairs. Interestingly, there is a gap in legal scholarship between insolvency literature and the literature discussing effective corporate governance for the solvent firm. Although one might conclude that this is because once a firm reaches insolvency a whole new bankruptcy regime takes effect and traditional notions of efficient governance do not apply, in reality, many of the same theoretical underpinnings drive decision making in solvent and insolvent corporations. For example, governance decisions involve efficient use of assets, accountability to residual claimants, and containing transaction costs. A key difference in the literature regarding governance of solvent as opposed to insolvent corporations is that insolvency scholars recognize the normative underpinnings of choices of models. Thus, for example, where market theorists, in discussing solvent corporations, argue against the importation of normative considerations, they fail to acknowledge the normative underpinnings of market theory. In contrast, bankruptcy scholars, even those endorsing market theory, may differ strongly in the policy objectives they advocate, but they often expressly recognize that these are normative choices involving preferences for a debt collection or a rehabilitation model.7 The current theoretical debate centres on which policy objectives and policy instruments should be adopted in bankruptcy and insol-

Current Theoretical Approaches to Insolvency Law 33

vency law. Debate regarding policy objectives focuses on whether rehabilitation should be a substantive goal. It also considers whether consistency in the approach of corporate governance in and outside of insolvency should be an objective, specifically, whether there are compelling reasons to treat various stakeholders differently, depending on corporate solvency. The debate over policy instruments encompasses the procedures that should be adopted, how decision making should occur, and the optimal process by which competing interests are recognized or accounted for. The debate over policy instruments is distinguishable from that with respect to policy objectives because it leaves open the possibility of any outcome depending on perceived efficiency, wealth maximization, or other principles. However, these issues converge at various points in the debate. This chapter draws parallels between corporate governance theories generally and theoretical approaches to governance during insolvency and restructuring. These connections are necessary to understanding the conceptual framework set out in the next chapter. Corporate governance is the legal and practical system for the exercise of power and control in the business of a corporation, and includes the relationship of shareholders, directors and board committees, officers, and other stakeholders such as secured and unsecured creditors, workers, customers, suppliers, and local communities. Corporate governance is the decision structure that enables capital to be raised and utilized by the corporation in a cost effective manner to create wealth. It includes both mechanisms internal to the corporation and the regulatory framework in which the corporation operates. It is the mechanism by which various marketplace signals directly influence the composition of the management team, which in turn influences economic and financial decisions taken by the firm. Governance has been described as a function of five elements: the statutory regime that imposes duties on directors and officers; the common law fiduciary duties that constrain actions; mandatory disclosure requirements of securities systems and regulation of proxy voting by shareholders; capital structure; and the corporation's internal governance procedures.8 A growing literature, by scholars such as Lynne Dallas, Marleen O'Connor, and Faith Kahn, suggests a further element: corporate social and economic responsibility in the interests of both direct investors and the public.9 This is not only an element of governance, but an indicator of effective deployment of resources and optimal generation

34 Creditor Rights and the Public Interest

of surplus value for the corporation. In combination, these definitions contribute to our understanding of governance norms and have relevance for issues that arise in governance of the insolvent corporation. In the insolvency context, governance is essential to generating creditor confidence in the corporation's ability to successfully turn around its affairs, and is key to attracting new financing to implement the workout plan. The availability of additional financing is directly affected by the statutory restrictions and requirements in terms of both priority of such security and concentration of holdings. The share structure may have an impact on whether it is feasible to restructure. The transaction costs involved in altering share structure or corporate articles must be considered as well as the ease of converting debt to equity in a workout. The following discussion of the current theoretical debate over the policy objectives and instruments advocated by bankruptcy scholars reveals divergent views on the law's substantive goals. Much of the debate has been generated by American scholars, as the United States has a much more extensive history of restructuring.10 Although these theoretical approaches are complex and nuanced, four general approaches can be discerned. Market Theory Approaches to Insolvency Most scholars endorse the value of restructuring schemes, although they vary considerably in their policy objectives. Market theorists have as a policy objective the efficient operation of markets. On their view, the sole purpose of restructuring is to clarify priority of creditors' claims, to assist with liquidation or the smooth transition of control to creditors.11 Comprehensive legislation is viewed as unhelpful to the commercial resolution of cases. Market forces, not the government, should decide how to maximize creditor return and determine whether a corporation should be liquidated or restructured. This approach parallels finance and market theories of corporate decision making for the solvent firm, which start from the premise that the primary goal of the corporation is to maximize share value and that current share price reflects the market's best estimate of the value of future profits.12 Finance theorists suggest that once a firm is insolvent, products, capital, and other markets should be the sole determinants of whether the debtor corporation should survive. Absent the availability of a private workout in any particular case, it is more efficient to sell the firm on a going-concern or liquidated basis, deploying the assets and human

Current Theoretical Approaches to Insolvency Law 35

capital elsewhere in the market. A market-based auction will generate the highest bid for the corporation's assets, whether on a piece-meal or going-concern basis. These scholars generally suggest that public law should not intervene to rescue companies and compromise creditors' claims. Such strategies add transaction costs without creating efficiencies. The auction model assumes perfect markets, including full information such that the value of the firm can be determined through auction or other market mechanisms. It does not address managers' incentives to undertake projects that assist in retention of corporate control or other ex ante effects of a pure market model that may increase transaction costs and reduce optimal value realization.13 Barry Adler has advocated the substitution of 'chameleon equity' as a market mechanism for existing statutory models: pre-insolvency contracts would provide for division of an insolvent firm and thus lower transaction costs.14 Chameleon equity is a multi-priority contractual hierarchy that would allow a debtor corporation to replace debt with a tiered hierarchy of preferred equity. The firm would retain the benefit of the discipline of debt payments on managers who know that they have to pay out earnings to investors who have the power not to renew loans, but it would avoid the negative consequences of creditor collective action, which frequently results in premature liquidation. On insolvency, default would eliminate the pre-insolvency common equity class, converting the next lowest ranking priority to the class of common shareholder. Managers would be accountable to the common equity class; thus governance of the corporation could continue during insolvency without periods of unaccountability and without costly court proceedings to determine value of the firm. These suggestions import helpful ideas about default control and reduction of collective action problems. Workers typically occupy a position near the bottom of the hierarchy (other than their preferred claims). The default equity approach could arguably provide them with a low-cost avenue to acquire governance rights if there is no class of preferred shareholders ahead of them. However, chameleon equity is premised on pre-insolvency negotiations. Thus workers and other unsecured creditors with incomplete contracts face the same barriers of information asymmetries and lack of bargaining power under this model as they do under contract theory. Moreover, the model does not account for the ex ante costs of negotiating these contracts pre-insolvency. Robert Rasmussen has observed that market theorists advocating chameleon equity and similar forms of automatic cancellation have not demonstrated that the ex ante investment effects of these models

36 Creditor Rights and the Public Interest

are better or at least no worse than the ex ante effects of the current bankruptcy system. Ex post efficiency from reduction of current costs of bankruptcy law for the proportionally few firms in bankruptcy should not come at the expense of ex ante inefficiency for all firms in the economy. Under an automatic cancellation regime, corporate officers would have incentives to pursue inefficient courses of action, such as forgoing positive net present value projects to prevent change in the capital structure, or incentive to prematurely liquidate the firm to prevent default and thus elimination of pre-existing equity rights.15 Creditors would have new incentives to refuse additional financing, because default would result in acquisition of equity and control rights. Market theory has also come under sharp criticism because markets alone rarely determine decisions in modern commercial economies. Pure market theory fails to recognize the current reality of legal and economic regulation by the state via securities regulation and corporations and competition statutes. The state has intervened to assist corporations and to protect equity investors.16 The market is only one component that contributes to a system's ability to achieve the objective of successful restructuring of insolvent corporations, and a number of economic, legal, and political factors influence outcomes.17 However, market theory does remind us that any restructuring scheme must take account of markets: once the protection of the restructuring statute is lifted, markets will be a major determinant of the survival of the debtor corporation. A viable business plan is essential. This is particularly the case as distressed debt is increasingly traded and debtor corporations are unable to garner the requisite creditor support for a plan unless it will meet market exigencies. Markets are important indicators of future economic viability. Moreover, the shift to global capital and product markets has seriously influenced governance of the insolvent corporation during the period of decision making with respect to its future. The ability to attract financing on a competitive basis is key to the restructuring effort. The growth of distressed debt investors in insolvency workouts has created enormous pressure for timely turnaround and workout plans that generate short-term returns on their investments. Any restructuring plan devised must create efficiencies and enhance the value of the corporation such that it will be able to successfully compete in the market place. Insolvency law must be situated in the social and economic context in which corporations operate, recognizing that multiple factors affect restructuring decisions, beyond narrow assessment of commercial requirements on an individual case-by-case basis.

Current Theoretical Approaches to Insolvency Law 37 Debt Collection Theory

A theoretical approach that has gained recognition in the United States and Germany is 'debt collection' theory, which suggests that bankruptcy's normative policy objective is to collectivize the process by which a debtor's assets are made available to claimants.18 The sole policy objective of bankruptcy law should be the enhancement of collection efforts of creditors, with a view to maximizing creditors' wealth. This differs from pure market theory because it endorses state intervention to assist with collective action problems by creditors and costeffective enforcement of claims. Debt collection regimes prevent a 'race to the finish' to realize on claims to the value of corporate assets.19 The law should be utilized to overcome creditors' co-ordination problems regarding the common pool of assets. This can only be accomplished effectively if non-bankruptcy creditor priorities and entitlements are identified and translated without alteration into the bankruptcy forum.20 Thus a key feature of debt collection theory is that it advocates retaining non-bankruptcy law entitlements in bankruptcy and suggests that the law should not treat creditors or other stakeholders differently in or outside of bankruptcy. While the regime should help a corporation carry on business if it is worth more to creditors as a going concern than it would be wound up, rehabilitation per se should not be an independent policy objective because it does little to reconcile the diverse interests of creditors. Financing and investment decisions are different, and whether the debtor corporation should continue operating is a distinct issue from who ultimately owns its assets. This theoretical approach suggests that insolvency law creates a forum for deciding entitlements among creditors when the assets remaining are insufficient to cover all their claims. While numerous other areas of the law such as environmental and labour law, are affected by an insolvency, debt collection theorists argue that it is a mistake to utilize bankruptcy law as a policy instrument to undertake accommodation of other rights.21 Debt collection theorists suggest that restructuring must be viewed conceptually as a form of liquidation in which the business entity is sold to the creditors themselves because the assets are worth more to creditors than they would be if sold to third parties. When the firm is restructured, proceeds from the 'sale' of the corporation, out of which claims against the debtor corporation will be paid, are primarily new claims against the same firm. Determining the value of the payment to creditors without using a market pricing mechanism is, according to

38 Creditor Rights and the Public Interest

debt collection theory, the hallmark of a reorganization plan. A decision to restructure or liquidate should be made solely on the basis of which strategy generates the greatest aggregate dollar equivalent return on the assets for creditors.22 This determination is distinct from a determination as to what claims are outstanding against the firm's assets. If a workout is worth more to creditors in terms of retaining their interest in the corporation, either in the form of debt or debt converted to equity, then the restructuring provisions of bankruptcy law should facilitate this. The question is how to convert ownership of the assets of the debtor corporation to the creditors in a cost-effective manner, not how to leave the assets with shareholders. The challenge lies in translating the diverse claims of secured and unsecured creditors, varying maturity of claims, and claims from contracts that offer specific performance as the remedy for breach into comparable forms for purposes of allocation.23 The principal contribution of debt collection theorists to the development of the conceptual framework in this book is their conclusion that one policy objective of insolvency law is to mitigate collective action problems. However, I suggest in chapter 3 that the definition of creditor should be expanded to take account of more than just fixed capital claims. A scheme that facilitates collective action problems is not antithetical to one whose objective is to facilitate a turnaround of the business affairs of an insolvent corporation where appropriate. Rehabilitation and debt collection theorists have been unable to reconcile their respective views on the objective of bankruptcy law as one of rehabilitation at considerable cost to the interests of creditors with that of satisfying creditors' claims without regard to the contribution that the corporation may make to the economic life of the community in which it operates. But these views are extreme and there is considerable scope for a more balanced approach. A policy objective of encouraging workouts where there is a viable business plan and support of the majority of creditors does not mandate rehabilitation at any cost. Similarly, one can endorse both the policy objective of effective debt collection and the notion that there should be limits on the period in which the debtor corporation can try to secure the support of creditors and other stakeholders for a restructuring plan that maximizes the value of their claims and allows for effective transfer of that value to creditors. The conclusion by some legal scholars that there should be no accommodation of public laws,

Current Theoretical Approaches to Insolvency Law 39

such as environmental or labour law, in the bankruptcy regime is also questionable. The entire scheme of a common law jurisdiction is a balancing of complex aspects of private and public law. Courts must deal with the realities of the situations in front of them and these fact situations are rarely purely 'commercial law' matters. In corporations law, this weighing of prejudice is frequently accomplished in terms of balancing private commercial activity with shareholder remedies or director liability for environmental harm. To suggest that bankruptcy law should always take priority and thus need not accommodate other substantive law ignores what currently occurs within the solvent corporation. Consistency within and without of insolvency requires balancing of these considerations in any restructuring scheme. Having made that observation, it is noteworthy that one debt collection theorist, Douglas Baird, raises an important question that has not been answered by scholars arguing for special consideration for broader stakeholder interests in insolvency law, and which needs to be taken into consideration in developing a coherent framework. Many firms close, fail, or restructure outside of court-supervised protection, and such cases ignore the problems of workers and other stakeholders. Why should considering such losses be a policy objective for bankruptcy law alone?24 The loss for the stakeholders is the same whether or not parties resort to the statutory scheme. Baird questions why those least able to bear the costs of firm failure or closure are given status in insolvency court proceedings but bear the costs outside of bankruptcy. Arguably, creditors should not bear the burden of special priority for workers and others in bankruptcy when shareholders are not required to bear this burden outside of bankruptcy. Legal rights should turn as little as possible on the forum. Otherwise, parties will forum shop by structuring their activities on the basis of distributional concerns and potentially turning to insolvency proceedings to escape onerous contractual obligations.25 Those who take issue with debt collection theory argue that there is no common pool of assets to which creditors have a claim prior to bankruptcy and that the notion of a common pool derives entirely from the bankruptcy scheme that allows for the orderly settlement of creditors' claims.26 Credit is frequently given with the expectation that the corporation will continue to operate and thus generate income to ensure repayment of debt and interest that accrues to creditors. Yet secured creditors usually also factor the risk of non-payment and firm

40 Creditor Rights and the Public Interest

failure into interest costs. The creditors' right to payment derives from the right to a portion of the income generated either from the economic activity of the firm or the proceeds from liquidation.27 Debt collection theory has made normative choices about the values that reorganization schemes should enshrine, that is, existing pre-bankruptcy legal entitlements. Yet there is some question as to whether bankruptcy law should protect pre-insolvency rights to the exclusion of any other considerations, such as social adjustment costs and economic havoc wreaked on communities. Debt collection theory mirrors the dominant theoretical approach to governance of solvent corporations, which reinforces maximization of share value as the singular and optimal goal of corporate decision making.28 On insolvency, the residual claimants become the creditors and the singular goal should be to maximize creditor value. Law and economics scholars view the corporation as a nexus of contractual relations and directors and officers as agents of shareholders. Thus, when the corporation is solvent, corporate officers should be accountable exclusively to shareholders in order to ensure decision making that results in the maximization of shareholder value.29 The market promotes efficient and accountable use of resources, and thus those investing share capital, or their agents, should have exclusive carriage of decision making. This efficiency will maximize wealth to the ultimate benefit of society.30 These theorists do not recognize that corporate decision makers have an obligation to act in the interests of stakeholders such as local governments, workers, and communities.31 While some scholars acknowledge that others may have an interest in the success of the corporation, they advocate that any rights accorded to these stakeholders ought to be strictly limited to contractual and statutory rights.32 These governance theories are firmly grounded in property rights and notions of residual ownership of the assets of the corporation. Consequently, when the firm becomes insolvent, directors and officers of the corporation, while still agents of the shareholders, now have an obligation to take account of the interests of creditors in terms of deciding the most efficient use of resources. If they fail to do so, creditors will move to enforce their claims through liquidation. Instead of shareholders owning a proportional share of the value of the residual assets of the corporation, the creditors now acquire the right to a proportional share of the value of the corporation's assets in order to

Current Theoretical Approaches to Insolvency Law 41

satisfy their claims. While not strictly ownership in terms of title, at the point the firm becomes insolvent, the entitlement to proceeds from disposition of assets carries with it property claims. For the solvent corporation, theoretical approaches to corporate governance reflect these value-maximizing goals. Widely accepted agency cost theory views corporate governance as having the singular objective of maximizing shareholder value by controlling managerial abuse while minimizing agency costs associated with its monitoring and prevention.33 Narrowly cast to maximize shareholder wealth and reduce transaction costs, agency theory does not take into account other investments in the firm. For the insolvent firm, agency theory addresses how to minimize transaction costs in the realization of creditor claims, the focus on shareholder wealth maximization and control rights shifting to an almost identical focus on traditional creditor wealth maximization. This shift is premised on the fact that there is little or no equity remaining in the corporation and that any claims to the assets of the corporation have shifted primarily or exclusively to creditors.34 Statutory language and judicial interpretation have reinforced these dominant theoretical approaches to corporate governance in North America.35 Courts have given judicial deference to business judgments that maximize shareholder wealth, assessing the process of corporate decision making as opposed to the correctness of the decision. Theory and practice converge to create and legitimize a view of corporate governance narrowly cast to focus on shareholder interests. Consistent with this approach, when directors and officers fail to govern effectively, or when market or other forces place the firm in financial difficulty, any opportunity to continue decision making necessitates that managers have regard to the new residual claimants to the property of the corporation, the creditors. Given the structure and hierarchy of credit in our society, this really means secured creditors, who can usually lay claim to most of the insolvent corporation's assets. Market and debt collection theories are limited in their analysis because their definition of interest recognizes only equity and debt capital investment in the firm. They ignore the other investments that contribute value and which may be vitally important to decision making in terms of wealth maximization. A key question is therefore how to account for all investments in the firm and how to devise a governance structure that encourages decision making that will maximize value while simultaneously controlling transaction costs.

42 Creditor Rights and the Public Interest Rehabilitation Theory

A third theoretical approach is 'rehabilitation theory/ in which the primary policy objective is preservation of the firm as an ongoing entity. France, Italy, and the United States all employ this type of model. The underlying premise is that insolvent corporations may be so important to national or local economies that these interests take precedence over original capital investments. Thus, the state is justified in compromising existing creditor claims in order for the debtor corporation to attract new capital. The rehabilitation approach bears some resemblance to the social welfare theory of corporate governance in which the policy objective is a system that operates to ensure that the corporation serves a broad social purpose, premised on normative notions of social welfare.36 The difficulty with a pure rehabilitation model is that considerable numbers of insolvent corporations are worth more on a liquidated basis than as going concerns. Rehabilitation does not adequately account for the problem of deferred liquidations, those that should occur but are delayed by a regime that accords too much value to the objective of rehabilitation. Moreover, rehabilitation may not always benefit the greatest number of stakeholders. Deferred liquidation can place the interests of secured creditors, trade creditors, and workers at further risk because it requires continuing investment in the insolvent firm when that debt and human capital could be productively deployed elsewhere. If a corporation is preserved that does not have the potential to become financially viable, workers and trade creditors may benefit temporarily, but they will be induced to continue investing human and other capital and will suffer even greater losses when the firm ultimately fails. Deferred liquidations may work to the exclusive benefit of shareholders, in that they are able to maintain the existence of the corporate entity even in cases where there is no hope of a turnaround. This is a key deficiency of the U.S. rehabilitation model. Corporations enter reorganization proceedings for many years, to the detriment of both traditional and non-traditional creditors. Ultimately, the firm fails because the singular policy objective of rehabilitation is not sufficient to overcome the deficiencies in terms of an effective business plan. A more recent and nuanced articulation of this theoretical approach suggests that a 'humanistic view' of bankruptcy law should be the central policy objective, and that American bankruptcy law should be

Current Theoretical Approaches to Insolvency Law 43

revised to expressly recognize 'forgiveness, fresh start, and rehabilitation.'37 Karen Gross observes that debt forgiveness is humane, encourages risk taking, and has economic benefits that allow the debtor company to choose between liquidation and reorganization. She suggests that current bankruptcy law be amended to recognize unsecured creditors, based on size and the impact of non-payment, and that definitions of classes could reflect those considerations. Secured creditors' rights would be unaffected under this model. The presumption of equality of treatment of unsecured creditors' claims would continue, but a creditor could rebut the presumption by demonstrating that equality in distribution would be unconscionable or create extreme unfairness or irreparable injury. Thus, pay-outs to creditors might retain the same value but payments could be accelerated for those for whom the loss has the greatest impact. Tort claimants and other involuntary creditors should be able to rebut the presumption of pro rata distribution if they are able to demonstrate unconscionability.38 Gross advocates amending the U.S. Bankruptcy Code to permit the court to take account of community interests unless the balance of equities in a particular case favours denying this consideration of interest. The court could then exercise its equitable jurisdiction to change the distribution based on equality of outcome as opposed to equality of treatment, taking account of community interests in cases where there is a nexus between the debtor corporation and harm to community. The practical question of who would represent the community in the proceedings is left to the court. Criticism of this theoretical approach has been aimed primarily at the weight placed on the equitable powers of bankruptcy judges and their inherent ability to make judgments regarding 'humane considerations.'39 Another concern is that taking community interests into account is impracticable and would internalize the costs of bankruptcy to the firm by making existing claimants pay for the social and economic costs of firm failure.40 These criticisms may be valid if the idea is to import judicial discretion into consideration of broad interests without regard to the economic and legal system in which the corporation is operating. A scheme that allows judges to override statutory priorities for credit without consideration of which investments are at risk in the firm would create uncertainty for creditors making decisions regarding risk assessment and the granting of credit prior to insolvency. However, this is not what Gross is advocating. She suggests that the U.S. Bankruptcy Code be amended to more accurately

44 Creditor Rights and the Public Interest

reflect the impact of firm failure and set a new normative hierarchy of interests among unsecured creditors that recognizes impact of loss where parties can meet statutorily imposed tests. This codification would provide the court with direction in the exercise of its discretion, and thus reduce judicial uncertainty. Gross suggests that this override would be an exception to the current hierarchy and essentially delink the debtor corporation's reorganization goals from creditors' need to be paid where a creditor's survival is at risk.41 Marjorie Girth has suggested that an alternative approach would be to amend bankruptcy legislation to add tort victims with physical injuries as preferred or priority creditors, with a system of creditor notification. The statute could provide for interim payment to those involuntary claimants who are being irreparably harmed by the length of reorganization proceedings.42 This priority payment approach merits further consideration. However, it may create over-inclusion of creditors, particularly tort claimants who may not merit special treatment because the harm they have suffered is not unconscionable or a threat to the claimant's survival.43 This over-inclusion may in turn diminish the recognition of other equitable and capital claims that are more deserving of special consideration because of the nature of the investment or the harm inflicted. It could also detract from a determination of whether there is a viable workout. Karen Gross' rehabilitation approach has distributive consequences. Yet, as I suggest in the next chapter, the current regime has ongoing distributive consequences and the normative underpinnings of these current distributional effects need to be made visible. Gross distinguishes her approach from that of communitarians by arguing that she is not advocating a broad social welfare model, only a policy approach that takes account of a community touched by the financial distress such that it is entitled to seek relief under bankruptcy law. This is a helpful notion. Most insolvency schemes involve distribution of value to creditors, and often not on a strict priority basis in terms of their claims. The issue is whether the decision to compromise those claims should be left largely to those with the claims or accorded to the judiciary. If judges exercise discretion in a scheme of rigid credit priorities, community or other interests are unlikely to be given precedence over more traditional creditors' claims, except where the harm is so egregious that the stakeholder would likely have a claim in tort or on some other common law basis. If the scheme allows the exercise of judicial discretion only for unconscionable outcomes, then the exer-

Current Theoretical Approaches to Insolvency Law 45

cise of discretion will be infrequent because the nature of harm, while serious, likely would not fall within defined notions of unconscionable harm. The requirement that the community establish some sort of nexus of harm with the activities of the corporation also has merit. The challenge would be how to establish this nexus in a manner that can quantify the harm and thus the claims to value of the debtor's assets while still controlling transaction costs. The definition of value is a critical part of the inquiry. Consideration of broader interests should arise where there are economic investments deserving of some sort of residual claim, where communities can establish an interest in terms of their investments in the debtor corporation, or where there are claims arising from tortious or similar conduct. Gross observes that while community interests should be placed before the court in a restructuring proceeding, she is not advocating that the community be given the right to vote on approval of a plan. Rather, the adverse economic consequences of a proposed plan are part of the court's consideration.44 This would make the court's current practice of taking community or the public interest into account more visible, create transparency with respect to the basis on which judicial decision making occurs, and enhance the current balancing of interests that the court engages in. Marjorie Girth has suggested that the 'public interest' could be addressed by a statutory requirement that a 'community impact statement' be placed before the court in each restructuring proceeding, just as environmental impact statements have been required when a proposed plan has the potential for 'significantly affecting the quality of the human environment.'45 She suggests this could be accomplished either as part of the debtor's disclosure requirements or by the U.S. trustee. Scholars have argued that wealth creation ultimately benefits society and that this is the appropriate role for corporate governance. Consideration of community interests would create excessive transactions costs and inhibit wealth creation.46 These scholars view consideration of stakeholder interests as benevolent or public law activities. They fail to take into account the human capital investments made by workers or investments made by local communities in infrastructure that supports the corporation. However, the issue of controlling transaction costs is a legitimate concern for insolvency law. The challenge lies in crafting a policy instrument in which diverse interests are recognized, but the process is efficient, controls transaction costs, and as-

46 Creditor Rights and the Public Interest

sists in generating value for the corporation. Gross' rehabilitation model deploys a range of policy instruments, reminding us that these various theoretical approaches share common elements, such as respecting the hierarchy of secured claims, and that they occupy a place on a continuum of bankruptcy theory rather than constituting rigid exclusive categories. Enterprise Theory in the Governance of Insolvent Corporations Some of the concerns identified above may be addressed in part by enterprise theory. Like debt collection and rehabilitation theory, this approach draws on a mix of policy objectives and instruments. For example, both Thomas Smith and Gregory Crespi suggest that the efficient norm for corporate law, in and outside of insolvency, is to maximize the total value of all claims on the corporation, and thus enterprise value maximization should be the normative objective of corporate decision making.47 The 'rational investor' envisioned in law and economics scholarship would, under modern financing, invest in a fully diversified portfolio, including equity, debt, and hybrid investments such as options and derivative securities. Under a capital-assets pricing model, rational investors will diversify across all classes of capital assets, and thus managers should, based on agency theory, maximize the value of the diversified portfolios rational investors would hold. Recognizing the growing complexity of corporate capital structures and diversified market portfolios of investors would result in a recasting of the substantive objective of corporate decision making as one of enterprise wealth maximization. This would address the inefficiency of the current shareholder wealth maximization model.48 Thomas and Crespi also suggest that the shift of fiduciary obligation to creditors when the corporation is insolvent or in the 'vicinity of insolvency' is an artificial distinction, because all firms are at risk of insolvency. Even large, well-capitalized firms can make a low-probability decision that ultimately places their solvency at risk. A product manufacturing decision that gives rise to mass tort actions would be a good example. Enterprise value maximization would eliminate the need to determine when the corporation is in the vicinity of insolvency, because the governance obligation would be to maximize the range of value across debt and equity regardless of the firm's solvency. It would also reduce the uncertainty created by uneven judicial approaches to the question of fiduciary obligation 'in the vicinity of

Current Theoretical Approaches to Insolvency Law 47

insolvency.'49 While this model does not address non-capital inputs, it does recognize enterprise value maximization as the objective both in and outside of insolvency, using a traditional capital assets pricing model. Crespi notes that fiduciary obligation to the corporation as a whole would preclude corporate pursuit of pre-insolvency projects that have a positive impact on shareholder wealth but a negative impact on overall corporate wealth, which in turn would reduce the ex ante costs of creditors negotiating protective covenants to accomplish the same end.50 There is growing scholarship that recognizes that modern economies are made up of enterprises reflective of interests broader than traditional creditors and shareholders. This theoretical approach is not aimed at any particular outcome, but rather represents an effort to move away from the narrow view that the policy objective of bankruptcy law is to maximize value in the interests of asset claimants. It is distinguishable from rehabilitation theory because it does not advocate saving the corporation as the substantive objective. Maximizing enterprise value during the restructuring process can also be distinguished from maximizing the value of equity.51 This approach suggests that bankruptcy and insolvency law should have as both policy objective and key policy instrument the establishment of a forum where all the interests can be heard regarding the possible restructuring of the insolvent corporation. Suppliers, employees, customers, and local governments may all have an interest in the workout, even if that interest cannot be translated into current capital claims. Elizabeth Warren suggests that the fundamental policy objectives of bankruptcy law are to enhance the value of the corporation, to distribute value according to multiple normative principles, to internalize the cost of business failure to the parties dealing with the debtor corporation, and to enhance private monitoring.52 Bankruptcy law is also intended to provide an orderly approach to debt collection; to distribute the costs among those at risk having regard to relative ability to bear the costs of default; to create incentive effects on pre-bankruptcy transactions; to identify similarities of interest among creditors; to ensure that shareholders bear the loss when the business fails; and to balance the equities in terms of benefits to the bankruptcy estate. There must be an effective means to deal with a debtor corporation's multiple defaults and to distribute the consequences of financial distress among the different parties. A reorganization mechanism also benefits those who have an interest in the corporation's continued existence

48 Creditor Rights and the Public Interest

although they may not technically be creditors, such as older employees or trade suppliers whose current claims have been satisfied.53 Bankruptcy policy should rationally consider the effects on those who are least likely to spread the risk of default and who are unable to bear the costs of firm failure. Thus, restructuring schemes should acknowledge losses of those dependent on the continued operation of the enterprise and redistribute some of the risk of loss from the default. Even where the outcome is liquidation, the scheme should accommodate the loss in jobs. The difficulty lies in determining what values are to be protected in the distributional scheme and how conflicting values are to be reconciled in a timely manner. The enterprise theory approach parallels the work of scholars in corporate governance who have suggested that on firm failure, the consequences to workers with specialized skills and to key suppliers are serious, because those workers and suppliers often do not have alternative markets for their labour or products.54 Thus, decision-making rights should not be limited to insolvency situations; rather, those with investments in the corporation should have access to decision and control rights when the corporation is solvent. While shareholders should not be disenfranchised, control rights in the corporation should reflect a clearer understanding of both ownership and investments at risk.55 Residual interests and control rights should not be measured at the point of liquidation, but in the medium term where business decision making is still active and more directly affects risks of firm gain or loss.56 These scholars advocate a governance model that endorses a policy objective of enterprise wealth maximization. Enterprise wealth maximization differs from traditional creditor wealth maximization in that the latter is aimed at maximizing the existing capital claims on the assets of the corporation. Enterprise wealth maximization attempts to view wealth maximization more inclusively, to include human capital and other kinds of firm-specific investments. Criticisms of enterprise theory include a claim that private law should not concern itself with public policy; if governments want to protect the interests of stakeholders, they can enact statutory protection under labour, environmental, and other remedial legislation. Bankruptcy law sets a priority for settlement of claims and injecting other decisionmaking rights into restructuring will harm those priorities. Thus there is objection to importing what is characterized as 'social policy' into bankruptcy policy, where insolvent firms have an obligation to protect stakeholder interests in a manner that non-bankrupt firms do not.

Current Theoretical Approaches to Insolvency Law 49

There is also concern that importation of stakeholder interest will lead to judicial uncertainty in decisions and increased transaction costs. Some of these concerns are legitimate and are addressed in the conceptual framework proposed in the next chapter. The vigour of the debate regarding the objectives and instruments of bankruptcy law is itself a product of different normative choices made by these theorists. Andrew Keay has observed in the U.K. context that notions of the public interest run throughout the insolvency and bankruptcy regime. It is in the public interest that insolvencies are resolved in an orderly and expeditious manner through a collective procedure that allows for distribution of assets to creditors, thus preventing a race to realization.57 Keay also notes that it is in the public interest to ensure that commercial morality is enforced in order to prevent fraud and other improper pre-insolvency practices. Finally, it is often in the public interest that a company is rescued in order to protect people from the adverse effects of insolvency. Public interest is thus implicated in all aspects of the bankruptcy regime and not confined to its rehabilitative aspects. Keay suggests that a definition of public interest is illusive and may involve maximizing social wealth and distributing it equitably, particularly where the insolvency affects the public generally or a section of it.58 He suggests that careful definition must be made of whose interests are implicated in the firm's insolvency and advocates a more comprehensive conceptual understanding of the link between the public interest in commercial as well as consumer bankruptcy. Keay concludes that for purposes of insolvency law, the 'public interest' involves taking into account interests which society has regard for and which are wider than the interests involved in a particular case, specifically the debtor and creditors. Public interest is an objective societal norm as opposed to an individual interest or an accumulation of private interest. In Canada, the statutory scheme that facilitates corporate workouts generally affords traditional creditors the opportunity to participate in negotiations for a plan or proposal. The aim is to simultaneously protect creditors' rights and assist the debtor corporation in restructuring its affairs in an effort to become solvent. Similarly, court-appointed officers are often directed to assist with the development of a plan, having regard to the protection of creditors' claims. In many respects, the Canadian insolvency regime has most closely resembled debt collection theory, with a slow but consistent move along the continuum towards both rehabilitation and enterprise models in recent years. For

50 Creditor Rights and the Public Interest

solvent corporations, clearly the shareholder wealth maximization model continues to provide the dominant theoretical approach to Canadian corporate governance. During insolvency, Canada's regime shifts primarily to a secured creditor-oriented process, with creditor support essential to court approval of a workout. However, it does not entirely adopt debt collection theory, because shareholders are given a role in negotiations for workouts and there is an express public policy of allowing debtor corporations the opportunity to devise a plan to restructure their affairs. The recent shift in Canadian insolvency law towards a greater balance between the debt collection, enterprise, and rehabilitation models is analysed at some length in the case studies in chapters 5 to 8. Courts have made reference to 'public interest' and 'social stakeholders' in determining participation and decision rights. Yet this shift necessitates three observations. First, Canadian courts have continued to emphasize that the process is ultimately creditor-driven. Second, the argument for the public interest is frequently made by the debtor corporation or senior creditors to bolster their own position on whatever issue is before the court. Some of the stakeholders that arguably comprise part of this public interest are often not before the court, either because they are unaware of their claims and their right to participate in restructuring proceedings, or because their interest and participation rights are unclear. As discussed above, even where stakeholders can establish a claim such that they are recognized creditors, often they lack the information or resources to participate in the negotiations for a workout or in the court-supervised process. Third, it is worth noting that the recent shift along the restructuring spectrum has created some discordance with corporate governance theory generally. There is no indication that the courts are shifting the property-based notions of shareholder wealth maximization that have so strongly characterized corporate case law. Yet in insolvency, there is marginally less reluctance to intervene to accord at least participation rights beyond a narrow creditor wealth maximization model. This may be the result of the courts' reluctance to divest shareholders of all decision rights in the restructuring process, notwithstanding the fact that they often retain no equity in the corporation at the point of insolvency. The recognition of these participation rights for shareholders opens the door for recognition of other interests not strictly defined by fixed capital claims.

Current Theoretical Approaches to Insolvency Law 51

Effective Corporate Governance in the Turnaround of the Insolvent Firm There is no shared definition of what constitutes a successful restructuring regime. As the discussion above illustrates, the indicia vary depending on the normative choice of policy objectives and instruments. What is deemed effective governance will be measured in terms of the policy objective, whether it is efficient debt collection, rehabilitation, or enterprise wealth maximization. Successful restructuring can be measured by size of return to creditors over the short term; by successful retention of jobs; by direct and indirect costs incurred in the process, including whether the assets are being put to their most productive use; or by the financial state of the corporation some years later, and its ability to survive in the market.59 Before setting out an optimal framework for decision making during insolvency, it is helpful to consider what factors are likely to contribute to the successful turnaround of an insolvent corporation. The factors necessary to the economic health of a firm have been the subject of exhaustive study and are too complex to deal with comprehensively here. However, key indicators can be highlighted. These are measures that the courts, senior secured creditors, and other stakeholders will have regard to in determining whether to agree to a particular workout. Indicia are drawn from across a range of normative theories, discussed in terms of the policy objectives and instruments of an effective insolvency regime. Achieving the Policy Objectives Insolvency law can have the simultaneously competing objectives of maximizing creditor recovery, preserving going-concern value where possible, preserving jobs and communities affected by firm failure, and enhancing the credit system generally.60 Asset value maximization as the sole indicium fails to capture these competing policy objectives. Recognition of these multiple objectives means recognition of where interests converge or diverge on any particular set of facts, and consideration of the extent to which restructuring instruments can achieve some or all of these policy objectives. A policy objective of maximizing enterprise wealth can be measured by whether production has been maximized; whether there is a

52 Creditor Rights and the Public Interestrest

resultant generation of consumer surplus and overall welfare of the enterprise; whether the corporation has provided opportunities for workers to remain productive; whether a greater flow of profits to investors has been generated than would occur if they invested elsewhere; and whether the flow of benefits to suppliers or creditors is such that they have made optimal use of their capital and supplies.61 Effective turnaround may occur where these complex relationships interact in a cost-effective, productive, and innovative manner. The optimal restructuring system should capture any going-concern surplus value and transfer that value to creditors in the form of equity or cash without increasing the probability of bankruptcy.62 Another measure of whether the system is achieving its policy objectives is whether it is responsive to the economic and credit considerations presented by the insolvency of the corporation. A firm in financial distress may be economically efficient but suffer from changing markets. In such cases, the best option may be to devise a plan that allows the firm to keep operating where there is a current or expected future market for its output. This may be the optimal strategy when there is no current higher value use, thereby saving efficient but financially distressed firms.63 However, when the firm is economically inefficient and change in governance practice will not remedy its financial distress, the best outcome may be to liquidate and release the capital to higher value uses. For some scholars, the issue is exclusively whether creditors receive greater value in a restructuring than they would in liquidation, and net gain or efficiency is not part of the inquiry.64 Yet radically changing the governance practices can generate value for the firm. It is important to ascertain the reasons for the corporation's financial distress in order to best fashion and evaluate remedies. Preserving going-concern value may not in itself be an adequate measure of effective restructuring, because it ignores the governance role of debt. Insolvency has often signalled inefficient use of assets or managerial slack or incompetence. Unless these problems are addressed in the restructuring decisions, going-concern value will not be enhanced, the firm will ultimately fail, and costs of that failure will be borne largely by creditors.65 Value must be enhanced, not merely preserved, in successful implementation of a restructuring plan. Measuring the Effectiveness of the Policy Instruments Legal scholars have suggested a number of indicia for measuring the success of policy instruments. These relate primarily to cost, allocation

Current Theoretical Approaches to Insolvency Law 53

of decision and control rights, and the need for pragmatic processes to build consensus for a restructuring plan. Criteria include whether the scheme successfully avoids premature liquidations while preventing deferred liquidations; the availability of a low-cost process for maintaining the priority of claims; confining the direct costs of the restructuring (i.e., fees of lawyers and court-appointed officers); containing the indirect costs of lost investment opportunity; and considering the costs borne by other stakeholders such as employees, customers, and the state, costs that are not part of the financial claims on the corporation in the event of default and which are not usually taken into account in making the decision to restructure.66 Restructuring should be cost effective, ensuring not only that the assets of the corporation are put to their best use but that the administrative costs are not a bar to realizing that best use. Whether the restructuring can be accomplished in a timely manner such that there is no further unnecessary depletion of the value owing to traditional and non-traditional creditors is also an issue. An equally important indicium is the effectiveness of the decisionmaking process in development of a plan and negotiation with stakeholders. The scheme should allocate decision making in such a way that decision makers bear the costs of their decisions. Otherwise decision making is likely to be unaccountable and will fail to adequately benefit the collective interests involved.67 Negotiations for a workout, whether private or court-supervised, should also occur at early sign of financial distress to maximize firm value.68 The generation of wealth by the corporation is enhanced when decision makers have an interest in the viability of the corporation. While there is considerable debate regarding who has an interest in a firm and what rights should be assigned to each class of interest, greater control and decision rights by investors, including creditors, can arguably enhance performance. The issue is whether directors and officers of corporations are maximizing wealth creating potential by engaging in decision making that considers the effect of those decisions on all stakeholders who have contributed inputs to the enterprise. The extension of this reasoning is that a measure of an effective decisionmaking process may be whether stakeholders have participation and decision-making rights, particularly where they have incentives to devise viable restructuring plans. Whether the plan involves conversion of debt to equity, deferral of claims, or further human capital contributions, it requires additional or continued investment by all of the constituent groups. High buy-in will help to ensure that only plans

54 Creditor Rights and the Public Interest

that will generate additional value will ultimately obtain the approval of creditors, other stakeholders, and the court. Wealth creation is also enhanced when shifts in equity ownership are combined with enhanced control rights in the form of co-determination or enhanced decision making in governance of the firm.69 On approval of a restructuring plan, the owners or investors in the firm are often considerably different from pre-insolvency owners. Although some of these differences are reflected in the appointment of new boards of directors and a shedding of existing managers, the new directors and officers reflect the interests of the largest stakeholders, in other words, the senior secured creditors or new equity capital investors. However, if the goal is to implement creative strategies to enhance productivity, in assigning any revised decision and control rights consideration must be given to all investments at risk in the firm. The rights at issue could include board membership, monitoring, or other control rights. Finally, in terms of pragmatic considerations, measuring the success of the policy instrument includes assessing the effectiveness of three distinct stages in the workout process. The first is what one restructuring expert has characterized as the 'stability seeking phase,' in which creditors, court officials, and restructuring managers must assess the situation to determine whether there are means to stabilize the finances of the corporation.70 At this stage, creditors require information to allow them to make informed choices about continuing to supply goods and services or extending credit. The second phase is the restructuring stage, in which corporate officers and creditors are searching for a formula that is likely to restore the viability of the corporation. Essential to any restructuring is building the confidence of major creditors, especially through frank acknowledgment of the extent of the firm's financial difficulties.71 Stakeholders must be persuaded that there is good reason to increase their financial risk. Finally, there is the stage in which the debtor corporation delivers a plan that can be executed and then proceeds to implement it.72 Successful restructuring facilitates debt collection and maximizes value for creditors while minimizing transaction costs. Yet this cannot be the only measure of a successful scheme. Where there are multiple policy objectives, successful turnaround must be measured against multiple indicia, including maximizing creditor recovery, preservation of investments, and maximization of going-concern value where possible. Whether non-traditional creditors with considerable interests

Current Theoretical Approaches to Insolvency Law 55

in the corporation are given the opportunity to benefit from the surplus generated by both their past and future contribution to the corporation should also be considered in assessing the success of a restructuring plan. The challenge is to ensure that the framework clearly defines the policy objectives of restructuring, the instruments through which this can be accomplished, and the indicia by which success can be measured, a task undertaken in the following chapter.

3 Proposing a Conceptual Framework for Reconciling Stakeholder Interests

'Texture' is defined as the 'character of fabric resulting from the way in which it is woven and the arrangement of constituent parts and structure.' 1 The courts have held that the CCAA represents a 'complexly interwoven ... exchange of economic interests'2 and that insolvency and bankruptcy 'work well into the social and economic fabric of a territory.'3 Judicial interpretation has thus set the stage for an attempt to develop and clarify the relationship among the various elements of the corporate fabric. A more 'textured' approach to insolvency law requires a clearer understanding of the way in which debt, equity, and other interests as constituent parts of the insolvent corporation can be interwoven within the corporate structure to create a viable business plan. Building on the historical underpinnings and theoretical debate set out in the previous two chapters, this chapter establishes a conceptual framework for approaching insolvency restructuring. Public policy is shifting towards a model that facilitates a going-concern solution where there is surplus value to be realized. A sound framework is needed to recognize the diversity of interests implicated in the firm's financial distress; to facilitate decision making that will enhance value; to measure and account for all the costs associated with restructuring or firm failure; to respect current priorities such that there is continued confidence in the credit system; to address collective action problems while controlling transaction costs; and to provide certainty to parties in their own decision-making processes.

A Conceptual Framework for Reconciling Stakeholder Interests 57

The framework proposed draws on elements of the debt collection, rehabilitation, and enterprise wealth maximization theories discussed in chapter 2 to advocate a policy objective of enterprise value maximization, having regard to all those who have investments at risk in the corporation. While rehabilitation should not be the exclusive goal of insolvency law, a workout is frequently the course that will best maximize enterprise value and best recognize the diverse interests of all those with equity capital, debt, human capital, and other investments in the corporation. On insolvency, the interests of stakeholders are complex and not easily categorized. This chapter commences with a discussion of the convergence and divergence of these interests when decisions are being made about the future of the insolvent firm. This discussion is designed to illustrate the collective action and information asymmetry problems that must be addressed in any conceptual framework. Five components of the framework proposed are then set out. The first policy objective is to allow insolvent corporations the opportunity to restructure where a business plan can be devised that is acceptable to the majority of creditors and which can be undertaken in a timely manner. The policy instrument advocated is a framework that creates optimal and informed decision making, accounting for all of the costs of insolvency. A second policy objective recognizes that workers, as human capital investors in the firm, are uniquely situated and deserving of consideration in the decision-making process. Third, the framework should recognize other stakeholders, such as governments, trade creditors, or local communities, that may have interests greater than the quantum of their fixed capital claims, reflecting an interest in the future of the corporation. Fourth, decision making regarding the future of the insolvent corporation must be undertaken with a view to maximizing the wealth of the enterprise. The instrument through which to accomplish this goal is a recasting of fiduciary obligation on corporate directors and officers to require decision making that will maximize enterprise value. Finally, the framework must have as an objective, recognition of the priority of traditional creditor rights and creation of a scheme for balancing those interests with the other interests discussed in this book. The Convergence and Divergence of Stakeholder Interest An effective insolvency regime must assist in resolving collective action problems, necessitating a better understanding of the divergence

58 Creditor Rights and the Public Interest

and convergence of stakeholder interests and the potential for alliances during the negotiations for a workout. Decision making as to whether a corporation should restructure, be sold to third parties as a going concern, or be liquidated on an asset basis does not occur on a purely creditor/shareholder axis. It is too simplistic to suggest that creditors seek liquidation and managers, as agents of shareholders, want to continue the firm at all costs. Rather, given the diversity in types of security, credit, priority or statutory preferences, maturity, amount at risk, and impact of loss of investment, the interests of parties are complex, diverse, and dependent on the particular fact circumstances. Rather than rigid categories of aligned interests, the convergence or divergence of interests will depend on a number of factors. Stakeholders can be broadly defined as all those who have investments at risk in the firm. This definition includes secured or unsecured creditors, shareholders, workers, directors, officers, local governments, and possibly tort claimants or communities that suffer some form of loss on firm failure. For more 'traditional' creditors, the 'stake' that these parties have in the firm, their fixed capital claim, has long been recognized. Where new kinds of interests are making claims to a proportion of the value of corporate assets, the nature of the interest at risk requires further definition. It may include a portion of the interests claimed by workers, trade suppliers, or other creditors who have more traditionally recognized fixed capital claims, but who have made investments in the firm greater than the value- of those claims. It can also include those parties who represent broader interests, such as community interests in protection of the environment. In Canada, as in most market economies, we have a well-defined scheme of credit and an extensive legislative and regulatory scheme for the registering and enforcing of such claims. The scheme provides for realization of claims when a firm becomes insolvent or moves into bankruptcy. Any conceptualization of restructuring must recognize that the creditors' bargain is undertaken within the system of statutory and contractual entitlements already in place.4 At the point of insolvency, reconciling divergent interests often requires the intervention of the court, although, as discussed below, a key issue is who should hold decision-making power when parties undertake negotiations for restructuring. Even among secured creditors there are frequently differences in interest, depending on the size and maturity of their claims and a hierarchy based on type or order of registering the claim. Restructuring may delay secured creditors realizing on their security, thus creat-

A Conceptual Framework for Reconciling Stakeholder Interests 59

ing possible diminution in the realizable value of assets, deferred realization of proceeds, and/or use of their security by the debtor corporation to fund the negative cash flow. The willingness of secured creditors to participate in workout negotiations may depend on whether the firm's chance for successful turnaround outweighs these disadvantages. Secured creditors are more likely to opt for liquidation if they can recover most or all of their investment, whether sold on an asset basis, a going-concern basis, or some combination of the two. There may be advantages to secured creditors if the debtor becomes bankrupt, because in bankruptcy, provincial trust claims are generally subordinated to the status of secured creditors. Even where there is potential for a successful turnaround, delay in the workout process can result in a serious erosion of the value of secured claims; thus any system must be highly responsive to the need for timely resolution of the financial distress. Banks and similar lenders often hold fixed or floating charges over a considerable portion of the assets and may be able to recover a greater percentage of their claim if the debtor corporation is liquidated. Creditors are unlikely to support a workout if they conclude that corporate officers are merely using the statutory scheme to delay an inevitable bankruptcy. At the point of insolvency, traditional creditors are incomplete residual owners in the sense that there is only a limited upside to restructuring, the satisfaction of existing fixed claims. Unless the proposed plan includes conversion of some debt to equity or other upside potential, these creditors may not have incentive to agree to a restructuring plan.5 Even if secured creditors have concluded that liquidation is not the optimal strategy, their ability to recover under such an option gives them considerable bargaining power in the negotiations for the restructuring plan. Secured transactions may thus not be efficient in workout processes: the secured creditors' preference on default can change pre-bankruptcy priorities and create inequitable outcomes by virtue of their bargaining leverage.6 Bondholders and debenture holders often have already exercised some oversight of the corporation's activities through their loan and debenture agreements, and that experience will inform their conclusion as to whether it is in their best interests to let existing managers attempt to restructure.7 Secured creditors can also make agreements about their relative priority, who has access to what assets, or who is able to realize first in priority through subordination agreements. Given that such agreements are usually made when the corporation is sol-

60 Creditor Rights and the Public Interest

vent, the existence of these relationships may influence potential alliances among creditors. Senior debt or public debt may be the subject of secondary market activity, and thus debt may be traded to new creditors at a discount. These creditors may have little interest in a potential going-forward value of the insolvent firm.8 Edward Sellers et al. observe that as distressed debt trades, ad hoc committees that represent the interests of public debt holders often then become members of formal creditors' committees, thus wielding considerable influence in the workout process.9 Unsecured creditors are the most unlikely to be paid their claims, absent some sort of statutory preference. Comparative studies in the United Kingdom and Germany, for example, have found that at liquidation, unsecured creditors receive on average a pay-out of 2 to 3 per cent of their claims.10 The Canadian experience is reasonably similar; one study indicated that unsecured creditors had an average recovery rate of 5 per cent.11 The size of claims may vary considerably, as well as the ability to bear the losses. For example, landlords have preferred claims to rent arrears at the point of bankruptcy, and may or may not be facing repudiation of their leases in a restructuring.12 Some suppliers have limited secured credit under existing provincial property security statutes, including use of such credit instruments as purchase money security interests.13 Given that their claims are attached to specific assets, whether their interests will converge or diverge with those of other stakeholders will depend on how the value of their claim may be potentially maximized. Unpaid trade suppliers have limited inventory recovery rights, based on strict timing and other criteria. As the court observed in T. Eaton Co., this remedy is frequently illusory, as it is difficult to meet the statutory criteria.14 Restructuring does not trigger suppliers' repossession rights, and the debtor corporation is free to deal with unpaid goods during the restructuring period.15 This is directly relevant to their support for a restructuring plan. Many suppliers are unable to diversify their risk. They may lack information and resources to evaluate credit risk, or they may be dependent on the debtor corporation as the principal customer such that bankruptcy would impose heavy losses for unpaid supplies. The primary assets of debtor corporations that have small borrowing bases, such as perishable goods, software, or research and development, have little value in liquidation. Such firms often rely more on trade credit than banks or other institutional lenders, and their ability to successfully negotiate a workout depends on continued

A Conceptual Framework for Reconciling Stakeholder Interests 61

supply of that credit. Even for more sophisticated suppliers, assisting a customer in a workout may be more valuable and less costly than acquiring new customers. Thus the interests of trade suppliers and the debtor corporation may converge if it appears that amiable terms of credit during and after the restructuring period can be worked out. While trade suppliers are not required to advance further credit during or after the restructuring process, they may determine that it is in their long-term interests to do so. Advancing further credit may increase the likelihood that some portion of their prior claim will be recovered, and these suppliers may gain from future business with the debtor. Since they are able to require that any further supplies are undertaken on a cash-on-delivery basis, they need not follow normal commercial practices, thereby placing an even greater amount of their capital at risk. Suppliers, franchisers, and licensors often face contractual arrangements that specify that termination is permitted on commencement of insolvency, and these parties may be concerned about the loss of goodwill if they are not able to arrive at a restructuring agreement acceptable to the majority of creditors. One might be tempted to conclude that since unsecured creditors are likely to receive little if anything out of liquidation, they will support a restructuring plan in the hope that value may be generated to pay their claims. However, if the restructuring is unlikely to increase the probability or amount of recovery, unsecured creditors are unlikely to support the plan. Some creditors have particular rights to enforce claims under statutes such as the Repair and Storage Liens Act and the Miners' Lien Act.16 While lien claimants are stayed during the CCAA period unless the court has lifted the stay, ultimately such claims cannot be subordinated without the consent of the lien claimants, and most of the case law suggests they cannot be overridden by the court in endorsing a motion for priority financing for the restructuring.17 For certain statutory lien claimants the effect of bankruptcy can be to reverse the priority of claims, because the scheme for distribution in bankruptcy prevails. Thus, statutory restrictions may result in the interests of these claimants diverging from those of other creditors. With the growth in claims trading, as discussed in the previous chapter, the unsecured creditors in the restructuring proceeding may not be the same creditors as those that historically have had an interest in the viability of the corporation. Unlike pre-insolvency unsecured creditors, who are disadvantaged by information asymmetries and lack of bargaining power, distressed debt investors are relatively

62 Creditor Rights and the Public Interest

sophisticated. They have access to information, given their concurrent secured claims, and they use their economic leverage across multiple classes of claims to advance control rights in the workout process. They have frequently purchased the claims at a severely discounted value, because of the economic vulnerability of small creditors, and are seeking to realize on the liquidation value of those claims. Hence their interests are less likely to converge with creditors that have a longer term, going-forward interest in the workout negotiations. The BIA sets out the priority of payments to preferred, secured, and unsecured creditors in bankruptcy, and these in turn influence determination of where interests align in the restructuring decision. These statutory provisions influence the environment in which creditors and managers bargain, and strict priorities and pro rata sharing might be compromised.18 Tax benefits accruing to a restructuring can also influence alignment of interests. Taxing authorities have particular rights that differ in and outside of bankruptcy. The wage and vacation claims of workers are given preference in bankruptcy, yet they are subject to other statutory preferences outside of bankruptcy. Notwithstanding remedies available for their fixed claims, workers often have an interest in a going-concern solution, as a means of protecting jobs and pensions. However, that interest may be indifferent as to whether the workers themselves purchase an interest or the firm is sold on a goingconcern basis to a third party, where the option includes preservation of jobs and benefits. Where third-party sale or restructuring entails labour downsizing, workers' interests are unlikely to align with those seeking the sale. Plans that recognize an equity or human capital investment by workers may be purely transitional - witness the worker buyout of the Abitibi pulp and paper mill.19 The union was not particularly sympathetic to workers investing further human capital in the form of wage and benefit concessions, but found it was a shortterm necessity in the circumstances. When the company was turned around, the workers sold their interest. In the case of highly specialized skills, interests may converge due to recognition by all parties of the need to retain the skills to maximize firm value. Where workers' human capital investments are more generalized, as opposed to firm specific, shareholders, managers, and secured creditors are less likely to recognize a convergence of interest with employees. Convergence of interest may occur where a number of creditors have a high probability of recouping some value if the corporation is reorganized. Institutional lenders or venture capital funds, who own

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more than 35 per cent of outstanding shares in publicly traded Canadian corporations, may be willing to endorse restructuring where it is accompanied by internal governance changes.20 The amount of investment combined with fairly rigid domestic and foreign investment rules means that such investors cannot easily liquidate their holdings if unhappy with corporate performance. Increasingly, these investors are looking to restructuring as a means of recouping losses. They have the resources to actively participate in workout negotiations and to insist on governance changes as a condition of their support. There are also considerations beyond those that are purely commercial that touch on the creditor's relationship to the social environment in which it operates. For example, banks may be reluctant in smaller or northern communities to be seen as the party that 'pulls the plug' on the firm, because they view these community members as current and future debtors. Bankruptcy and insolvency law recognizes tort, environmental, and other liabilities, and parties seeking redress for these harms may or may not converge in their interest. In Royal Oak Mines, several First Nations alleged that the British Columbia government had violated their rights by failing to consult them prior to granting particular licences and permits, and this allegation influenced their position on any workout.21 Tort claimants usually do not have investments in the firm; rather, they have a claim on firm assets based on the past conduct of agents of the corporation. Thus they may not have an interest in survival of the firm. For example, if injuries have already manifested themselves, tort claimants might well advocate liquidation as a ready means of settling claims, particularly if time is of the essence because of the nature of the harm. Unmanifested tort claims, such as those of asbestos victims, whose tort may be based on past completed actions but for whom there is a long latency period before the harm becomes discernible, may have an interest in successful restructuring with potential to generate value for the settlement of future claims. Moreover, if there are other possible avenues of settlement of claims, such as government funding, tort claimants may use the voting rights under restructuring legislation as a tool to bargain a better settlement outside of insolvency proceedings. This issue is canvassed more fully in chapter 7. While the assessment of whether going-concern value is worth more than liquidation influences the decisions of parties, these values are often difficult to quantify. Liquidation can mean large financial losses

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for various groups of creditors and costly litigation in determining priority and enforcement entitlements. Assessments by stakeholders of the feasibility, time, and cost of restructuring are key. Existing capital and products markets, future prospects of the particular industry, the skills of managers and workers, the availability of additional financing, the likelihood of sufficient creditor support, and the possibility of future profitability are all determinants of how interests will tend to converge or diverge and the likely outcome of insolvency proceedings. The role of corporate officers is also key, particularly in the initial stages of a restructuring application. Where the directors and officers have made considerable equity investments, these interests are more likely to converge with those of other shareholders, and these officers may have engaged in excessive risk taking as the corporation approached insolvency. For publicly traded companies, managers are frequently concerned about reputation and future job prospects. They may align in interest with institutional creditors and thus play a key role in protecting corporate assets from further unnecessary depletion. Given that they often have important informational capital to contribute to the development of a viable business plan, creditors may support their retention for at least some period. However, the vast majority of managers are replaced during or shortly after the restructuring process, and this may affect how they perceive their role in the process. These dynamics are often neglected in determining convergence of interest. Personal liability for employee wages or environmental harm may determine how corporate directors' interests align. Corporate officers may work to delay bankruptcy until they have taken steps to reduce their personal exposure, such as ensuring statutory preference claims are paid or a trust is created to cover any liability. For closely held corporations, the corporate veil may not be sufficient to protect active operators from personal liability. Moreover, these parties may be personal guarantors of particular debt, which secured creditors will pursue if there is not agreement on restructuring. Recent statutory amendments that allow for a compromise of claims against directors create ex ante incentives for directors to negotiate a successful plan in order to gain immunity from these liabilities.22 Where firms are closely held, there is also likely to be a strong desire to retain control of the company. Where shareholders are widely dispersed, they have the same collective action problems as they do when the corporation is solvent.

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They may have diversified their risk such that it is more cost effective to take the loss than to expend any energy supporting revival of the corporation. Shareholders may be more willing to tolerate high-risk decisions as the firm approaches insolvency, because they have everything to gain and little to lose. This directly conflicts with the interests of creditors, who want conservative fiscal management during this period in order to preserve remaining asset value to satisfy their claims. Shareholders receive little or nothing in a liquidation, and it is often in their interests to encourage restructuring, because they incur no further losses due to their limited liability. If there is a reallocation of equity on a restructuring, shareholder interests may converge or diverge from those of senior creditors in terms of endorsement of a particular plan. Stakeholders' interests can thus be linked to the threads used in weaving. Depending on the particular pattern of economic facts concerning a corporation's insolvency, the threads will converge or diverge as they are woven into the pattern. I am proposing that the ultimate pattern be determined in a framework that promotes the goal of maximizing enterprise value having regard to all the investments at risk. Given the diverse interests and complex risk-sharing arrangements involved in an insolvency, determining power relationships is key to a workout. Senior secured creditors have long been recognized as key participants, but there may be others who are important contributors to the potential turnaround. Compromises are inevitable in order to preserve the efficiencies of the collective action regime and maximize value for the group. Any distributional effects should be understood in light of the relationships and convergence of interests discussed above. Thus it is important that any framework reduce informational asymmetries among stakeholders. If stakeholder interests bring a synergistic effect to the firm, it may be efficient for creditors to negotiate a restructuring plan with the debtor. In Canada, recognition of a shift from the paramountcy of shareholder-centred governance for the solvent firm to creditor-centred governance during the period of insolvency fails to fully explain who should have voice and control rights in this exercise. While the framework set out below endorses the notion that creditor rights should be protected in restructuring proceedings, the public policy reasons for suspending enforcement rights during stay periods are the same policy reasons that provide support for redefining decision rights during restructuring negotiations. The stake-

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holders themselves, with the assistance of the court-supervised process where necessary, are in the best position to negotiate and agree on a value-maximizing strategy. Public Policy Recognition of the Value of Workout Schemes The first component of a framework for the governance of insolvent corporations is endorsement of current public policy that recognizes workout regimes as valuable. Companies experiencing financial difficulty should be given an opportunity to restructure their affairs to remain operating if it appears that a viable business plan can be developed that will be acceptable to creditors. Private workouts generally occur only when the corporation's ownership structure is simple, the creditors are relatively few in number, and the type of debt is uncomplicated. Yet most firm insolvencies today involve multiple creditors, a complex array of debt instruments, numerous international credit arrangements, and multiple classes of shares with different powers and payment obligations, resulting in a huge diversity of claims to the corporation's assets. Private workouts are often difficult to accomplish because during the negotiation period the debtor corporation is unable to prevent creditors from taking unilateral action to realize on their claims. The market alone is inefficient as a mechanism to maximize firm value, hence the need for the protective mechanisms under restructuring statutes. The assistance of a court-imposed stay creates breathing space for the corporation to try to devise a survival strategy and to persuade creditors of its merit. The current regime grew out of the necessity of having an orderly scheme for the negotiation, endorsement, and sanctioning of restructuring plans, and recognized the value of such plans by providing public resources to establish and maintain the scheme. The operating normative paradigm during insolvency is that decision making should be undertaken with regard to the interests of creditors in order to maximize the value of their claims. Given the statutory hierarchy of claims, in reality, creditor value maximization results in decision making in the interests of secured creditors, since the highly leveraged nature of most insolvent firms leaves little to satisfy the claims of unsecured creditors. Unsecured creditors often do not have the information or resources to participate in workouts, other than voting on proposed compromise of their specific claims. More-

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over, since workouts are dependent on the support of secured creditors, decision making is most often geared to maximizing the value of their claims. This weighting in favour of secured creditors promotes the policy objective of ensuring the availability of cost-effective credit. A theoretical underpinning of Canada's insolvency and bankruptcy system is that it is necessary to protect and encourage credit as a means to generate entrepreneurial activity and wealth creation; premised in turn on the assumption that credit can be enforced, particularly when a corporation is experiencing financial difficulty. There is an elaborate framework to enforce the hierarchy of claims. Creditors exercise default rights that include the ability to demand early repayment if the debtor corporation violates debt covenants or the ability to force the debtor into bankruptcy proceedings on specified non-payment events. Lack of enforceable mechanisms would pose a serious risk to businesses in their competition for capital. A counter-balance to the system of debt enforcement is the public policy recognition that firm failure results in severe economic hardship for numerous stakeholders. Unsecured creditors lose most or all of their investment; governments lose tax revenues and often incur the added social and economic costs of paying for employment insurance and welfare assistance; and workers are often unable to find secure employment at comparable wages. Workout regimes allow parties an opportunity to ascertain the likely cause of the financial or economic distress, which is key to determination of an optimal strategy for the future of the insolvent corporation. Insolvency can be the product of efficient governance that is overcome by competitive markets and variations in foreign exchange rates; thus firms may find themselves in financial distress despite good governance practices. However, insolvency can also be the product of inefficient decision making or excessively high-leverage financing. In these cases managers' practices have precipitated the problems, and restructuring may require a major overhaul of debt structure and/or governance practices. A restructuring regime offers an alternative to a strict liquidation scheme in which creditors try to maximize their proceeds from a sale, whether on an asset or going-concern basis. The premise of the scheme is that while it is a creditor-oriented process, there is a balancing of interests. For example, while there may not be equity remaining, shareholders may have made capital contributions such that they are deserving of some part of any future value generated if

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there is a successful turnaround. While the corporation negotiates with creditors to ascertain whether a viable plan can be devised, ultimately creditors have the right to enforce their claims. The second aspect of public policy recognition of the value of workouts is that the debtor corporation in most cases retains control of the business pending development of a plan. While the scheme does not go as far as the U.S. regime in terms of establishing a concept of a 'debtor in possession' operating the corporation in trust for the creditors, directors and officers do acquire an obligation to consider the interests of creditors in determining the best interests of the corporation. Numerous features of the system, such as short-stay periods and frequent reporting to the court and creditors, are integral to the scheme. They protect creditors' interests during this period and allow for a balancing of prejudice, with the court acting as both mediator and arbiter of diverse interests. The court-supervised process creates a costeffective forum in which multi-relational complex risk-sharing arrangements can attempt to find the optimal restructuring plan.23 Thus, judicial oversight is a key policy instrument. It assists with the reconciliation of divergent interests in insolvency and with promotion of the policy objectives of satisfying creditor claims and facilitating workouts where viable. Debt collection theory suggests that public interest objectives such as employment preservation or environmental protection have no place in bankruptcy law, because they disrupt pre-bankruptcy entitlements and detract from the core debt collection function of the statutory scheme. This approach focuses exclusively on creditors as the 'owners' of the corporation's assets, thus the only justification for restructuring is that it is better for its owners than alternative uses of the assets. In reality, neither shareholders nor creditors are 'owners' of the assets; rather, they have a residual claim to a proportional value of the assets. This pure ownership approach ignores other economic investments and interests at risk, such as investments by communities in the infrastructure that supports the local enterprise. Canadian judicial recognition of the public interest in restructuring proceedings is an attempt to recognize the social and economic consequences of any decisions taken, while preserving traditional creditor rights and the continued availability of capital financing. Public policy that values corporate workouts reflects the objective of assisting firms to devise a strategy to satisfy their creditors while remaining in operation. It is a balancing of interests rather than pursuit of a solitary

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objective of corporate rehabilitation or debt collection. The issue is not whether to take the public interest into account, but rather, the proper balancing of interests among parties that together comprise the public interest, including traditional creditors. Tilting the balance too much towards the public interest will lead to premature liquidations by traditional creditors. The problem is that, at present, the balance is tilted away from these interests. The current policy objective of giving corporations an opportunity to successfully restructure their affairs has not historically been accompanied by participation and decision rights for all those with an interest in the insolvent corporation. There are two types of interests held by these stakeholders. The first are those capital claims already recognized by the law, such as claims for wages, vacation pay, tax arrears, orders for environmental clean-up, and damages for tort. The second type of claim involves those interests that are not fixed capital claims, but which reflect economic interests at risk if the corporation fails. These include loss of firm-specific human capital investments; the cost of environmental harm to future land use and local community dependence on that use; and costs to trade creditors and local economies from lost merchant trade. This type of interest has not been formally recognized, although courts make reference to these interests under broad notions of the public interest.24 The insolvency scheme has focused on secured creditors, who obtain the right to insist that decision making in the corporation prioritize their interests, failing which those interests will be realized through liquidation. The paradigm still operates to recognize only those stakeholders who have capital invested in the firm, in the form of equity or debt. Workers as Equitable Investors with Enhanced Decision Rights The Canadian regime takes account of creditor interests almost purely on the basis of the nature and quantum of their capital claims. The definition of 'creditor' for purposes of insolvency law includes workers to whom wages and benefits are owed. Depending on the nature of the claim, workers are either statutory preferred creditors, unsecured creditors, or both. They and their unions may also be creditors by virtue of contractual obligations under collective agreements for which the debtor corporation is responsible. Moreover, trade unions may be unsecured or preferred creditors in terms of amounts owing in union dues deductions or remittances to pension plans and/or health

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and welfare plans. Thus, workers as fixed claimants have some rights to participate in insolvency proceedings. However, that participation has been severely limited because of the proportionally small amount of their fixed claims, and in the absence of the information and resources required to participate fully in any negotiations. In reality, workers are uniquely situated as human capital investors, and their risk of loss on firm failure is substantially higher than the value of their fixed claims. While the U.S. courts to date have expressly rejected recognition of human capital as a capital input in the context of the 'new value added' exception to strict priority, Canadian courts have not yet specifically addressed the issue of whether human capital can be assigned a value in insolvency proceedings.25 However, Canadian courts have acknowledged the importance of workers to the corporate enterprise and the generation of future economic activity. Moreover, the notion that workers' contributions to productivity, teamwork, innovation, and firm synergies enhance firm value and can be valued themselves are not novel concepts. They have formed part of compensation system design for many years. Workers bear a proportionately higher amount of transition costs associated with firm failure compared to other investors. Their interests run along a continuum of fixed and residual claims. Workers contribute their labour and loyalty over an extended period, conferring value on the corporation on the basis of implicit or explicit promises of job security and enhanced compensation. The promise is one of future reward for human capital investment today, commonly referred to as a deferred wage system.26 This system creates an incentive to make contributions to the firm that have value greater than that compensated for by wages and benefits, and workers have a reasonable expectation that these investments will be protected and valued by the firm. On insolvency, the employees' interest in implicit promises that their human capital will be rewarded in the future through better wages, benefits, job security, and job opportunity is not adequately protected by employment contracts or statutory provisions for termination and severance, as these provisions are aimed solely at fixed capital claims. In the insolvency context, this interest is the present value of what workers reasonably expected would be the return on their human capital investment had the firm not become insolvent. This interest may translate into claims for a proportional share of the value generated by any successful turnaround.

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Statutory standards or national insurance programs may be the optimal means of protecting workers' human capital investments in the firm in terms of their fixed claims. Equally, such schemes could be designed to recognize claims beyond fixed capital claims by creating comprehensive retraining programs and other measures to assist with adjustment harms. However, given the current trend of dismantling statutory protection, the investments of workers are unlikely to be protected through this means.27 The question, therefore, is whether there is a mechanism within existing insolvency law that will recognize those investments and give workers access to a proportional share of the value of the insolvent corporation's assets. Although insolvency law recognizes workers as residual claimants in a way that governance theory regarding solvent corporations has not, the nature of these residual claims is still narrowly defined as the fixed capital claims arising out of employment contracts and statutory benefits. Implicit in a more fulsome recognition of these investments is the challenge of discerning who should be governing the insolvent corporation during workout negotiations, who should be present at the negotiating table, and who should have decision rights in the ultimate outcome. Workers as human capital investors, like equity investors, have difficulty making complete contracts. Parties to the employment contract, whether it is express or implicit, are often contracting for an unspecified period of time and unfixed quantities and quality of labour. Workers seldom view the compensation package as compensation for risk of firm failure, and rarely are they able to negotiate terms of employment that account for the risk of firm insolvency. Contracting at the outset of the employment relationship for risk of unemployment is an exception, usually found where workers' skills are so specialized and in short supply that they have the bargaining power to demand a wage premium. One reason that workers join unions is that they have been unable to bargain for decent wages and working conditions in the absence of some collective action mechanism. While unionization has resulted in marginally greater protection for workers in terms of the solvent firm, unions have generally been unable to bargain for protection against the risk of firm failure, other than some small provision for termination and severance. Traditional contract theory makes four assumptions: that parties had full information at the time of the contract such that they could contract against a variety of foreseeable future risks; that where harm

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is not specifically provided for in the contract, this reflects the parties' agreement on risk assumption and compensation for that risk factored into the contract price; that parties understand that fiduciary duties flow exclusively to equity holders and the contract does not rely on that duty to fill any gaps in the contract; and, finally, that government intervention distorts optimal private bargaining.28 For a traditional creditor such as a bank, these assumptions of contract theory apply. The bank requires full disclosure before it advances credit and it factors the risk of firm failure into the amount and terms of credit. The bank understands that fiduciary obligation flows exclusively to the corporation, usually defined as shareholders, and thus does not rely on such a duty to fill gaps in the contract. More recently, however, lenders have successfully argued that on insolvency, that fiduciary obligation will now include consideration of creditor interests. Finally, government intervention does little to aid optimal private bargaining, given the high dependence of corporations on available and costeffective credit. The same assumptions of contract theory do not apply to employment contracts. The majority of Canadian workers do not have formal employment contracts and only 37 per cent of workers are covered by collective agreements.29 The majority of Canadian workers are not able to bargain collectively for compensation to reflect the value of their human capital investments or for protection against future adjustment harms. Workers and unions face serious information asymmetries, exacerbated by residual management rights theory and labour laws that do not require full disclosure of foreseeable risks. Unlike the bank example, workers and their unions do not have the bargaining power to insist on this disclosure prior to making employment contracts. Given current labour markets, it is also difficult to contract for potential harm to workers. Negotiated severance pay offers small protection against the loss of human capital investment. Even if unions try to bargain against 'future categories of risk/ such as firm failure, they do not have the bargaining power to secure contractual protection.30 Thus the risk of firm failure is not accounted for in the contract in terms of adjustment compensation, retraining, relocation assistance, or other mechanisms to protect human capital investments. Moreover, workers do not generally understand that fiduciary obligation flows primarily to shareholders and thus cannot be relied on to fill gaps in employment contracts. Nor do they assume that government intervention will distort private optimal bargaining. Government intervention his-

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73

torically enhanced employment bargaining, just as it has engaged the interests of shareholders under securities legislation. There is another way in which employment contracts differ from those of other creditors. On insolvency, the debtor corporation must bargain to retain supply contracts, as preservation of the value of such contracts may be key to the corporation's survival.31 Thus, there is incentive to negotiate terms that induce the creditor to continue granting credit in the form of financing or trade supplies during the period in which the corporation is trying to devise an acceptable business plan. In turn, such creditors can insist on disclosure in order to make an assessment of whether to continue extending credit during or after the workout. Collective agreements differ in that during the restructuring decision-making process, workers are not able to collectively withdraw their further investment of human capital. Canadian labour laws prohibit work stoppage during the life of a collective agreement.32 Thus the debtor corporation has no incentive for early disclosure or negotiation. Since unions have no right to renegotiate the terms of a collective agreement during the life of that agreement, restructuring decisions made in periods in between collective agreement negotiations do not require the corporation to negotiate with the union for protection against adjustment harms. This can lead to opportunistic behaviour by corporate officers, and the inability of workers to bargain for post-contractual harms to their human capital investments can lead to expropriation of those investments.33 Implicit contract theory suggests that workers bear residual risks from their firm-specific investment and that they are unable to foresee or adequately contract for risk of firm failure. It advocates enforcement of implicit contracts based on parties' actual expectations in terms of firm-specific investment and deferral by workers of payment in exchange for job security.34 Implicit contract theory recognizes that workers' investments should give rise to remedies. Yet it does not provide an adequate answer to loss of investments on firm failure. The premise is that on firm failure, managers are unlikely to harm employees because of loss of their own reputational capital and resultant depreciation in overall value of organizational capital. However, it is unclear that creditors or shareholders would be aware of managers' breaches of implicit contracts, or that they would necessarily recognize an interest in enforcing those contracts other than where the skills are sufficiently specialized that it is in the debtor's or creditors' interests to retain the workers.

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Implicit contract theory is also premised on the notion that workers are aware of breaches of implicit contracts and thus will withdraw or refuse to contribute their labour where managers have reputations of failing to comply with implicit contracts. Again, this theory ignores information asymmetries, lack of bargaining power, statutory prohibitions on the withdrawal of labour, limited employment choices and the inability of workers to easily relocate away from their community, the growth of contingent labour markets, and the issue of who currently has decision rights during negotiations for a workout. This adverse situation is exacerbated for employees whose first language is not English. Moreover, workers, other than in communities with small local labour markets, are unlikely to hear about breaches of implicit employment contracts. As a result, the argument for using reputational capital as a means of enforcing implicit contracts is highly questionable. While implicit contract theorists have suggested that implicit contracts would be enforced to the degree contemplated by the parties in accordance with their intentions, little attention is given as to how differences in intent would be reconciled in determining the actual substance of implicit contracts. Interestingly, this focus on actual intention of the parties is precisely what the remedial statutory scheme of human rights and labour law strove to eliminate because of the difficulty in establishing intention.35 While employees have expectations in employment, it is unclear that they can establish enforceable intentions in seeking remedies under implicit contracts. Tests of reasonableness of employee expectation likely differ considerably from reasonableness tests of implicit contracts grounded in the current shareholder or creditor wealth maximization paradigm. Thus, while implicit contract theory recognizes or values obligations to workers, it does not adequately address the risk to their investments on firm failure. Human capital investment generates value for the corporation through innovation, efficient production methods, generation of customer goodwill, and synergistic value generated when employees work effectively together. This value is rarely measured by fixed capital claims. It also frequently depends on the governance structure of the firm. Yet traditional notions of corporate governance continue to regard employees as fixed claimants without concern for the continued prosperity and viability of the firm. This position forms the basis for a rejection of stakeholder accountability other than through enforcement of

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contracts or bankruptcy claims. It is reinforced by the separation of corporate and labour law, in which any obligation owing to workers as fixed claimants is seen to be taken care of by the labour law regime, and in bankruptcy, by limited statutory preferences. There is no legislated protection of workers in the event of economic restructuring, beyond very limited notice and severance pay obligations in the event of closure or partial wind-up. The result of this traditional view of workers is that their investments in the firm are rarely fully recognized. Where there is highly firm-specific human capital investment, decision making by firms imposes a high risk on workers' investments, a risk comparable to that borne by equity investors. Unlike shareholders, who have the ability to diversify their holdings and ease of exit, often workers' human capital is invested entirely in the insolvent corporation. Acquisition of general as opposed to firm-specific skills is not as effective a strategy for diversifying risk as is the ability of shareholders to diversify their investment portfolios. Moreover, unlike secured creditors, who frequently account for possible insolvency in their cost of granting credit, workers rarely achieve such protection. Whether the corporation is ultimately liquidated or restructured, the outcome frequently involves wholesale shedding of workers. Thus traditional governance mechanisms provide inadequate protection against the loss of human capital investments. Individual employment contracts, collective agreements, and public and private insurance have all failed to efficiently spread the high risks of job loss.36 As a consequence, firm failure disproportionately affects workers. While the loss of investment is recognized in limited rights to claim severance, firms generally externalize the costs of economic restructuring in terms of retraining or relocation. As noted above, it is only when the skill set required is so specialized that corporate decision makers need to retain workers that the human capital potential of workers is accorded priority. In that case, any value accorded to that interest is reflected in priority payment of wages, usually in the initial stay order, as opposed to meaningful participation in workout negotiations. The assertion that workers risk their human capital investment does not depend on establishing that their aggregate risk of loss is equal to or greater than that borne by shareholders or other creditors. Rather, just as different shareholders and creditors have varying degrees of investment and varying abilities to diversify risk, so too do workers. This does not detract from the notion that when a corporation be-

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comes insolvent, creditors, shareholders, and workers have a residual interest in it. Like shareholders, the residual interest of workers at the point of insolvency may not be measurable in fixed capital claims or remaining equity, but it exists nevertheless. Equally, all parties have an interest in any future generation of wealth by the corporation. Workers' human capital investments result in their interest being located along a continuum of fixed and residual claims. Those claims, while not requiring shareholding to fall in the residual category, are nevertheless deserving of special attention in the governance debate. In order to determine their interests, and thus, to establish their claims, workers may need to be described differently from fixed or residual claimants. This description could encompass a notion of 'equitable investment' and equitable claims. Equitable notions are well entrenched in Canadian law, and equitable remedies have been available where courts have found that fairness or even-handedness required the ordering of a particular remedy. Concepts of equitable relief have recognized interests not strictly defined by title or by law, yet for which fairness suggests parties are deserving of remedies in particular circumstances. Applied to the governance context, workers have fixed claims under statutes and collective agreements, but their human capital investment may be deserving of broader recognition. While they are not always residual claimants in the traditional sense of possessing equity capital at risk on firm failure, they do have investments at risk, investments that are usually undiversified. Recognition of workers' equitable investments would have two immediate implications. First, in devising restructuring plans or determining whether the corporation should be liquidated, directors and officers of insolvent corporations would be obliged to consider the human capital investments of workers, just as they consider the equity investments of shareholders and the capital claims of traditional creditors. Moreover, just as shareholder interests are taken into account in restructuring negotiations, even though the value of their equity stake as measured by the future stream of expected earnings has been reduced to zero or almost zero, so too should workers' interests be taken into account, even though there is risk that the value of the future earnings generated by that investment could be reduced to zero. Both shareholders and workers have contributed capital, and that investment may give rise to a claim for a proportional amount of value generated if the corporation is able to successfully turn around its affairs.

A Conceptual Framework for Reconciling Stakeholder Interests 77 Assigning a Value to Human Capital Investments A key question is how human capital contributions can be assigned a value in a cost-effective and timely manner, such that these stakeholders can persuade the court, senior creditors, and the debtor corporation of their interest in the negotiations for restructuring. Without doubt, inputs to a firm by workers are difficult to value. Similar problems were encountered with respect to pay equity in the late 1980s. Resistance in Canada to private sector pay equity legislation stemmed from complaints that the 'value of women's work,' which was widely acknowledged to have been systemically undervalued and thus underpaid in the workplace, could not be determined easily or cost effectively. Yet fifteen years later, multiple valuation models have been developed to make visible and assign a 'gender neutral' value to work. This was accomplished largely through parties' negotiations, with judicial and quasi-judicial determination of questions where the parties concerned were unable to agree on the requirements of the statute. Any initial increased transaction costs were reduced once the parties acquired some history and judicial direction on how to value the work in question. In the insolvency context, the difficulty in assigning a value to workers' human capital contributions should likewise not be a bar to recognizing those contributions in such a manner that gives rise to participation and/or decision rights. Rather than relying on one precise formula for such a calculation, various principles can be applied to a calculation of human capital investments. These principles include calculation of the value of deferred compensation; recognition of innovative contributions to the firm; and valuing the generation of consumer or client goodwill. Such calculations should be similar to those already undertaken by actuaries in deriving final average earnings plans and by labour economists in the design of optimal compensation systems. Efficient wage theorists already take account of monitoring costs, productivity, and asymmetrical information when assessing compensation systems. Some of these principles can be applied to valuing human capital investments at the point of firm insolvency. First, it is important to calculate the value of deferred compensation. This includes both wages and benefits, given that in Canada nonwage benefits comprise 41 per cent of compensation. Deferred compensation systems are predominant in Canada. Wages are paid below a worker's individual productivity in early years, with the implicit

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promise that wages will be above the worker's productivity in senior years, especially pension accruals in the pre-retirement years. The excess of workers' productivity over wages when young will be returned in the form of compensation in excess of productivity when workers have accumulated seniority and a satisfactory work history with the corporation over a period of time.37 The premise is that deferred compensation systems provide performance incentives, increase productivity, and encourage teamwork and cooperative behaviour, because workers are not engaged in internal labour market competition to the detriment of productivity of the firm. Deferred wage systems also ensure firm loyalty and encourage workers to invest greater human capital in the enterprise. They reduce turnover costs and monitoring costs because deferred wages allow monitoring to be undertaken on a periodic retrospective basis. However, firms have an incentive to renege on the deferred wage obligation when that obligation becomes due, and thus it is important to have checks in the compensation system to ensure that these are paid. In the insolvency context, firms are reluctant to acknowledge the value of deferred wage claims because they increase the amount of claims outstanding against the value of the remaining assets of the corporation. However, this value must be calculated to clearly establish the quantum and types of human capital claims that workers have during the restructuring negotiations. Economists have observed that deferred wage systems provide workers with a financial interest in the solvency of the firm, whereas under spot wage markets, except for the transaction costs of finding a new job, workers are indifferent as to whether the firm becomes bankrupt.38 Translating that observation into the restructuring forum, workers are high-value creditors in terms of their interest in development of a sound business plan and turnaround of the financial condition of the debtor corporation. At the point of insolvency, deferred compensation claims can be measured by the current value of the promise of future compensation. This value can in turn be measured on the basis that the expected pay of workers is equal to the expected productivity over their expected lifetime with the firm. Averaged out over the existing service of the employee, one can calculate the amount of deferred wages owing. Indicia that could be used to value the deferred wage claim are local labour markets and the likelihood of workers finding employment at comparable wages, the impact of employee work efforts on quality and quantity of output; the amount of interdependence of employee

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effort in terms of productivity; and the recruitment, hiring, and training costs saved by the firm in the years prior to insolvency. One study has measured the impact of displacement of workers at the point of firm failure or market change, tracking the amount of permanent damage to earning capacity and gender differences in displacement costs.39 In order for the calculation of value to be timely and undertaken in a cost-effective manner, the present value of the investments across the entire workforce of the insolvent corporation, that is, of a creditor class of workers, must be determined. Again, there are precedents for this in the way in which actuaries currently calculate the investments required now to ensure adequate capital for future payout of pension benefits. In the insolvency context, the issue is the amount of money which represents the portion of deferred compensation owing that, on a balance of probabilities, the workers at risk of losing their investment will never be able to attain. Principles to apply in calculating value could include the following. First, the relevant variables to input into the calculation would be the ages of workers in the workforce at the point of insolvency; the years of service; the expected working life based on age; the present wage and benefits costs; and expected future increases in wages and benefits. From these variables can be calculated the gross compensation owing if the debtor corporation were to meet its promise of expected employment and earnings. Then, the formula would have to discount for a number of factors: the chances of workers obtaining comparable positions in terms of wages, benefits, and future course of employment; the chance of workers obtaining better opportunities; the fact that the claim is being realized now and not over a number of years; and the potential of statutory benefits such as the winding up of a pension plan. The value calculated, accounting for both the variables and the discounting factors, would be a measure of the present value of the human capital investments of workers. This value could then be translated into participation and voting rights in the restructuring process. Similarly, collective agreements currently accord value to workers' investments in their seniority provisions. Calculation of the present value of workers' equitable investments as well as future potential for investment is not antithetical to insolvency law. Practitioners have grappled with valuing human capital contributions by managers and models have been designed to assess the value of managers' current and future contributions to the debtor corporation. For example, one firm that frequently acts as monitor or

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receiver in the insolvency context designed a management assessment model to evaluate the effectiveness and potential of managers in the insolvent firm, including team ability, plan implementation skills, client needs, shared goals, and ability to identify and manage risk.40 Although aimed exclusively at managers during the restructuring period, it illustrates that the various human capital contributions already made and potentially available for the turnaround can be measured in a systematic manner. The recent development of 'key employee retention programs' in restructuring cases such as Loewen is another example.41 While such programs are aimed primarily at managers or highly specialized skilled workers, the methodology employed for calculating the value of past and future contributions may have application for broader groups of workers. It seems evident that some consideration of interests beyond fixed capital claims is already part of the restructuring equation. Traditional creditors do not negotiate solely in terms of their fixed claims, and a rigid system of governance based on illusive valuation concepts is unworkable. Pragmatic factors such as the need for speed and efficiency and the inability to accurately value interest require a fluid decision-making process. This notion also applies to equitable investments. Formal valuation processes are costly and may create a barrier to acknowledgment of workers' interests. It is possible, however, to quantify equitable investments. Accountants and actuaries currently price the costs and benefits of firm failure to community, trade creditors, and related businesses. However, potential losses in terms of gross revenue should be measured against a full consideration of costs to creditors. Parties could determine value through a variety of costeffective mechanisms. Even where the value of equitable investments is not quantifiable in a cost-efficient way, creative alternatives could be used to accord workers decision rights. The use of the 'one vote per tort claimant' for purposes only of voting on the Red Cross plan of arrangement is a good example (see chapter 7). While not necessarily the ideal method, and certainly not the most accurate, it provided an expeditious means of according decision rights in a case where time was of the essence because of the nature of the harm. Such an approach reflects norms of participatory democracy rather that the private law notion of voting by quantum of capital claims, and it speaks to the possibility of using mixed models of decision rights in the workout process. Once these investments are recognized and quantified, there are four key outcomes: enhanced participation and decision rights;

A Conceptual Framework for Reconciling Stakeholder Interests 8sts 81

more effective compromise of claims during the negotiation for a viable workout; the potential for enhanced corporate governance; and a recasting of fiduciary obligation to take account of all interests at risk in the insolvent corporation. Participation and Decision Rights That Flow from Valuing Equitable Claims One way to achieve substantive recognition of workers' equitable interests is granting workers participation and decision rights in the restructuring process. This could involve a range of participation rights such as increased access to information; an enhanced voice in the workout process; participation on creditors' committees; the resources to participate; and decision rights based on the calculated value of the claim of equitable investment in the firm. Just as shareholders may or may not have value to add to the restructured corporation, workers may or may not be able to offer a unique perspective in the restructuring exercise. Yet recognition of the informational capital they can contribute can be key to developing a viable business plan. Workers' inability to easily exit and their high firm loyalty create incentives for positive contributions to the design of a plan. Moreover, when directors 'jump ship,' governance is in disarray and directors cannot necessarily be counted on to monitor the activities of managers during the period of financial distress. Workers can provide a less costly means of monitoring the corporation's activities during this period. Posner and Kordana have observed that for the solvent corporation, the one-vote one-dollar system for governance reflects the strength of shareholders' incentives to make good decisions.42 However, when used in restructuring proceedings, this system fails to take account of those who have a strong post-insolvency interest in the corporation, the 'high-value' creditors, such as workers, small creditors, and trade suppliers. Combined with information asymmetries, this situation leads to strategic bargaining and less than optimal outcomes. Thus these interests need to be accorded more value than currently recognized in the fixed capital claim framework. In defining participation and decision rights that flow from workers' investments, we can draw on existing practices under insolvency law in terms of the rights that are granted to traditional creditors. Workers may have different claims to these types of instruments, de-

82 Creditor Rights and the Public Interest

pending on the nature of the investments that they have at risk in the firm. The recognition of workers' equitable investments would lead to enhanced participation rights as well as contributing value to the restructuring process. Participation rights can be defined as the ability to be heard in negotiations for a plan under a private workout or a court-supervised process. This includes having access to information to ensure informed and meaningful participation in the discussions. Participation can also involve the ability to contribute informational capital to the negotiations to ensure that all stakeholders can make decisions on an informed basis. Workers may have a first-hand understanding of production design inefficiencies, duplication of processes, existence of outdated equipment that signals the need for capitalization, and other information resulting from their direct work experience that allows them to identify production changes that would assist in devising a viable business plan. They can enhance value through their 'organizational capital/ which is the value and synergies generated from a team of people who work regularly together and the resultant efficiency that creates value for the enterprise.43 Such participation would allow negotiations for a restructuring plan that takes account of both the pre-insolvency investment and post-restructuring potential investment of workers. The challenge is to ensure that value is added by the inclusion of workers' participation in a way that outweighs the direct and indirect costs of the process. According participation rights might include allowing workers a representative on the creditors' committee, who could monitor the activities of the insolvent corporation and participate in the normal give and take entailed in negotiations for a viable workout. In Canada, creditors' committees are utilized in a variety of both passive and active roles in CCAA proceedings. This can include negotiating with the debtor corporation the terms of a workout plan; reviewing financial information and other disclosures on the corporation's operations and capital structure; acting as a sounding board for the monitor; assessing the governance of the insolvent corporation; or assisting in monitoring a going-concern sale. According workers rights to participate on creditors committees would reduce information asymmetries and allow for the informal exchange of views that so often facilitates a workout. It should also include the right to come before the court under the 'come-back' clause in stay orders, a right that creditors have been given to protect their interests during the stay period. Resources to ensure participation should also be made available. Under the cur-

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rent regime, creditors are partially financed for their activities out of the assets of the debtor corporation, usually on the same priority basis used in allocating administrative costs. Workers as human capital investors could be accorded similar access to partial funding to ensure that they are able to participate. Workers may also be positioned to propose governance structures that give all parties incentives to work together efficiently, thus reducing costs of coordination and dispute resolution. The second instrument for achieving substantive recognition of workers' interests is according decision rights. Decision rights are distinguishable from participation rights in that they carry voting rights on a proposed plan. Decision rights also create enhanced bargaining power, because the debtor corporation will seek to win workers' support for the proposed plan before it comes before the court in the sanctioning hearing. Workers, as equitable investors in the firm, should be granted enhanced decision rights in the negotiations for a restructured corporation, rights that reflect their fixed capital claims and their quantifiable equitable investments, both present and future. There are several practical ways in which decision rights could be determined. Existing fixed capital claims could be re-evaluated, based on some formulation that recognizes workers' human capital investment, as discussed above. Alternatively, workers could be given a separate voting class for purposes of voting on a proposed plan, which recognizes that they are uniquely situated because of the nature of their investment in the corporation. Currently, workers are usually grouped in a class with all unsecured creditors, rendering their voting power almost useless. Another option is that workers' equitable investments could be represented in a class of equitable investors and their fixed claims continue to be grouped with other preferred or unsecured creditors. The fact that workers might end up in more than one voting class is not antithetical to insolvency law. Distressed debt investors currently buy up claims across multiple classes in order to influence votes in each of the classes voting on the restructuring plan.44 Under any of these options, the court would receive the benefit of workers' views through the voting process, just as the court now receives the views of traditional creditors. Where the plan involves only compromise of fixed claims and not a restructuring arrangement, the court could still acquire the benefit of workers' views, although this might involve granting intervenor status and the right to make submissions as opposed to decision rights. This form of participation right

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is discussed below with respect to community stakeholders whose legal rights may not be affected by a proposed plan. A valuable analogy can be drawn to the situation of shareholders during insolvency. During the negotiation process for development of restructuring plans, shareholders, particularly in closely held Canadian corporations, retain important decision rights, although one court recently held that shareholders did not have decision rights where there was no reasonable prospect of any value accruing to them and the shareholders thus had no economic interest in the restructuring plan.45 While there is no requirement under the CCAA for shareholders to vote as a class in approval of a plan, courts have in the past ordered a vote of shareholder classes where a change in share structure required such a vote under corporations statutes. This approach reflects the central role accorded to shareholders in the solvent corporation. In insolvency, shareholder wealth maximization is not entirely subjugated to creditor wealth maximization, notwithstanding the fact that shareholders have little capital claim to the residual assets at the point of insolvency. While a negative shareholder vote is unlikely to defeat a plan that has the requisite level of creditor support, unless approval is dependent on changes to share structure, the court can still consider shareholder views in sanctioning a plan. Shareholders may also influence or dictate the method by which equity is restructured. Such participation rights recognize both the investment lost and, in some cases, the future right to participate in any value generated from the restructured firm, whether or not shareholders contribute any further equity capital to the corporation. Workers could likewise be given decision rights that recognize both the value of the investment lost and the future right to participate in value generated by the workout. These are distinguishable from any voting rights they may possess as fixed claimants under insolvency statutes. The courts would engage in the same kind of balancing of workers' votes on a restructuring plan as they engage in with other creditor votes. The importance of granting these rights is that the debtor corporation is then required to negotiate with the class in arriving at a proposed plan. The support or defeat by a voting class of workers will also assist the court in coming to an informed decision at the fairness hearing that sanctions the plan. The court would use the same tests that it currently applies to assess the fairness and reasonableness of the plan.

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In the past decade in Canadian insolvency proceedings, where workers and their unions have sought participation rights, the courts have generally granted them. In Anvil Range Mining Corporation, this occurred even where the workers' fixed capital claims had already been satisfied (see chapter 6). The courts expressly recognize that insolvency law is ultimately a creditor process and that it is driven in large measure by the scheme of bankruptcy priorities. The type and extent of claims that workers as equitable investors would support depends on the kind and quantum of human capital they have contributed, and on their reasonable expectations as investors of human capital in the particular enterprise. An equitable approach provides a more textured way of addressing the increasingly segmented and contingent nature of labour markets. Rather than grounding residual claims entirely on the notion of expectations of long-term human capital investment, an equitable approach could take account of situations where workers have made shorter term human capital investments which have been placed at risk. While greater than fixed claims, they may be insufficient to establish a full residual interest. Recognition of these claims could ensure that decision making considers all investments at risk in the firm. In turn, this could result in governance structures that allocate decision and control rights to those who have the incentive to use resources efficiently to create wealth. A central question in restructuring decisions is how to allocate value when the value of the debtor corporation is unclear and the market does not adequately reflect where the residual claims lie.46 In terms of human capital investment, once the value of that assessment is quantified in terms of claims, as discussed above, the court will be able to make a determination of the nature and scope of workers' participation and decision rights as equitable investors. Negotiating Outcomes to Protect Investments and Create Future Value The second consequence of valuing human capital investments would be that workers or their unions could then agree to arrangements or compromises that protect as much as possible their equitable investments, just as traditional creditors currently bargain to protect their debt claims. Recognition of actual entitlement based on their human capital investment could allow workers to extract a greater proportional share of the value in the negotiations for a workout. Valid com-

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promise of their claims could encompass future enhanced participation in the governance of the corporation, or claims that the corporation should give priority to job security in recognition of past or future human capital investments. There is evidence to suggest that workers only benefit in restructurings when any additional human capital or other investment is accompanied by a shift in the way in which the corporation is governed.47 What is needed is to enhance the capacity of workers to bargain for protection of their future as well as past investments in the firm in terms of a right to a proportional share of the future value generated and a more even distribution of the costs of corporate financial distress. In turn, the equitable investments of workers could be more explicitly recognized and utilized in the governance of the restructured corporation. This is not to suggest that workers' interests would or should always prevail. Rather, their fixed capital and human capital claims would be accorded a value, either on consent of the parties or by the court. As discussed above, this might involve a calculation based on years of service, contribution to productivity, or other actuarial calculation. This value would better reflect their claims and enhance their ability to negotiate for a workout. Successful development of a plan would then depend on cooperation and the requisite levels of support among stakeholders, as it currently does. The first cases measuring such value would provide parties with information regarding the type and value of such investments so that they can fruitfully engage in the delicate negotiations that ultimately lead to agreement on a viable plan. Under such an approach, the courts would be better able to balance the interests of workers with those of traditional creditors. Courts already exercise their equitable jurisdiction to balance the diverse interests involved in restructuring applications. Formal recognition of workers' equitable investments could result in enhanced negotiations and decision making for the plan. It would also create greater certainty in negotiations and ensure the courts' express consideration of workers' interests in the balancing that it undertakes in determining whether to sanction a plan. It would promote, where possible, an optimal workout that does not impose the adverse consequences of bankruptcy on multiple stakeholders. The underlying premise of recognizing workers as investors in the process to negotiate a workout is that there is value on the table that is otherwise lost. However, until that interest is fully recognized, work-

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87

ers and their unions will have to place the information before the courts to persuade them of the quantum of workers' investment at risk and the monetary impact of future opportunities given up today. This approach, combined with proposals for other stakeholder recognition, discussed below, would contribute to the courts' definition of the public interest as well as reducing transaction costs in the workout process and inappropriate externalities in terms of the costs of firm failure and potential restructuring. Formal recognition would allow workers to express any interest they have in gaining access to the governance of the restructured corporation. Workers may or may not desire governance change, depending on their political philosophy, or that of their union, and on whether they view their role in the restructuring as purely transitional or a long-term, investment. As with any creditor in the restructuring process, a demand for seats on the board or other control rights would not be guaranteed. Such a demand would be part of negotiations, and unions as exclusive bargaining agents of workers would participate because of their members' fixed and equitable claims. Failure to reach a negotiated agreement on governance changes would be reflected in support for the plan in the vote, such as occurs with traditional creditors now. Much of the discussion so far has assumed that a union is in place that will represent the collective interests of workers in a cost-effective manner, thus controlling transaction costs in the restructuring process. However, in some instances non-unionized workers have overcome collective action problems in CCAA applications by forming workers' committees representative of employees. The resolution of the pension surplus issues in the Birks case, for example, involved employee representatives undertaking an organized process of information dissemination, thus facilitating the restructuring process, reducing transaction costs, and apportioning 60 per cent of the pension surplus to the employees.48 Moreover, if a pension trust is involved, those workers can be named as a class under class proceedings statutes or pension legislation and representatives of beneficiaries and legal counsel may be appointed for them. In T. Eaton Co., the court granted status to a representative employee, authorized to represent all current and former employees in negotiations with the corporation. Legal and professional costs were authorized by the court to be paid on the same priority basis as the interim receiver or trustee in bankruptcy.49 This created a mechanism whereby the voice of the workers was being heard as part

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of the workout process, despite the absence of a union to represent their collective interest. One issue that deserves future study is whether the recognition of workers' equitable investments will be facilitated by institutional investors whose funds are derived from workers' contributions. In the United States, pension funds, as institutional investors, are increasingly seeking governance changes in and outside of insolvency, in many cases resulting in enhanced corporate performance of targeted companies. The role of TIAA-CREF in the Loewen workout is a good example of this.50 Institutional investors have in some cases recognized that the balance sheet does not adequately capture the value of human capital investment to the debtor corporation. They have begun to make investment decisions that seek to maximize return on their investments by improving corporate governance. They frequently measure long-term economic performance through workplace practices as one indicium of overall value generated by the firm.51 When insolvent firms are seeking sources of capital in restructuring negotiations, such investors can use their bargaining leverage to require enhanced consideration of workers' interests and investments. In Canada, pension funds and other worker-funded institutional investors such as Labour Sponsored Investment Funds (LSIFs) are key existing and potential investors in the decision to restructure insolvent corporations. In 2001, trusteed pension plans in Canada managed $568.6 billion in assets, 40 per cent of which was invested in stocks.52 Since pension funds are required to own 70 per cent of their assets in Canada, they have limited opportunity for exit, leaving governance strategies as the most viable option to maximize value. However, pension funds are bound by court decisions that have held that their fiduciary duty is solely to the current beneficiaries, not to employees as future beneficiaries.53 The U.S. funds have overcome similar restrictions on fiduciary obligation, but Canadian pension funds have not to date taken the same steps to protect workers' interests in terms of governance. Gil Yaron has suggested that the institutional investor has a unique role in Canadian economic activity and that its fiduciary obligations include responsibility to invest with a long-term view to meet the financial needs of beneficiaries and ensure the sustainable social and economic framework required to provide for future beneficiaries.54 Institutional investor activism is a mechanism to protect shareholders against investment risk and a vehicle for directing governance of the firm to optimize long-term benefits for beneficiaries, the corporation,

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and the economy generally. A national poll conducted in 2001 indicates that a majority of beneficiaries of pension plans want institutional investments to be made in corporations with 'good social responsibility records.' Thus there appears to be increasing support for at least a partial recasting of fiduciary obligation by pension funds to recognize these broader interests.55 There is considerable potential for such a recasting in the insolvency context where the business is clearly viable and where the short time frame exigencies of the workout process do not bar access to institutional capital. Workers are increasingly bargaining for joint governance of defined benefit pension plans, and continuation of this trend may result in alteration of their governance priorities. Pension funds have been the source of funding in a number of successful CCAA applications and, in at least one case, the fund itself proposed a plan that formed the basis for successful negotiations.56 Similarly, the growth of LSIFs has provided an important source of capital that may potentially recognize human capital investments.57 Institutional investors funded by workers' investments may be one vehicle to protect human capital investments in insolvency. However, these investors will likely be interested in only the lowest risk workouts, given their fiduciary obligations, unless they are already investors in the insolvent firm. In that case, exit is problematic and their at-risk investments may give them bargaining power that assists workers. An Expanded Definition of Stakeholders While workers may be uniquely situated in the governance debate, they are not the only stakeholders not fully accounted for in insolvency proceedings. Local communities, governments, and others have investments at risk, although these interests may be harder to fully determine. Where the stakeholders can establish equitable claims, recognition should be made of their interests. Like those of traditional creditors, the interests of non-traditional creditors or stakeholders do not necessarily converge. An expanded definition of stakeholder can take account of two broad types of interest. The first are those of stakeholders who are already recognized as creditors in terms of statutory preferred claims, Crown claims, or claims at common law but have interests beyond the fixed capital amounts of these claims. Some are involuntary creditors, such as tort claimants or claimants under home warranty or similar consumer protection legislation. Others may

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be voluntary creditors, but they did not contract for risk of firm failure and resultant economic loss. Stakeholders may have fixed claims that are relatively insignificant in terms of overall amount of debt, but equitable claims of greater value. The second type of interest are purely equitable claims, those investments in the firm that have not traditionally been recognized other than under broad notions of the 'public interest.' This could include interests such as concern by local businesses about the spin-off economic effects of firm failure, the interest by northern communities in access to cost-effective air transportation, the interests of consumer groups that any workout ensure that the restructured corporation's product lines do not harm those who purchase or use the products, or the interest of community in preserving local infrastructure, such as schools, that support the corporation's economic activities. Often stakeholders with a mix of fixed capital and equitable claims are interested in both remedies for past action, that is, taxes owed and remedial environmental orders, and future operations, such as local economic activity or protection of the environment. The State Restructuring under the CCAA essentially involves a public law system governing a predominantly private law set of negotiations. A key question is the appropriate role of the state in the restructuring regime. The 'state' is not monolithic. It is comprised of federal, provincial, and local governments, with numerous departments, agencies, and Crown corporations implicated in diverse economic activities that may be affected by a corporation's financial distress. The state also includes the policy makers and legislators whose mandate is the implementation and monitoring of public policy. Moreover, the interests of the state are not implicated in the same way in every case. Thus it is important to distinguish government in terms of direct or indirect economic interests from the larger policy interest the state may have in ensuring that a successful restructuring regime is established. Where there is an identifiable economic interest, the state in one form or another may choose to participate in a CCAA proceeding. Where the interest is purely that of public policy, there is probably no rationale for government intervention in a particular proceeding. Local and provincial governments have an economic interest beyond debts owing for property taxes or public utilities. For example, in Royal Oak Mines, the British Columbia government had contributed

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$162 million in economic assistance and investment to the Kemess Mine, yet its concurrent interest was environmental protection. One of the cash flow issues facing Royal Oak at the time of the initial stay order originated in a B.C. Ministry of Environment order to temporarily cease operations at the mine pending resolution of outstanding environmental issues.58 Often local governments have invested in a corporation in terms of building schools, community centres, parks, and other infrastructure that supports the firm's employees in the community. This investment is frequently based on express or implicit promises by the debtor corporation that continued economic activity will be generated by the corporation in their community. Local governments agree to waive zoning by-law requirements or not to enforce environmental protection orders in the expectation that the corporation will remain actively in business. Local government and community members invest with the expectation that their investments will be recovered through future economic activity of the firm. Despite the investment made, local governments rarely have the bargaining power to negotiate compensation for risk of insolvency. Governments are then left with the costs of social and economic upheaval occasioned by firm failure. These include not only costs to welfare, social service, and health care but also losses to municipal tax bases and the adjustment costs of attempting to retrain workers and to generate recovery of the local economy. In recent years, these costs have been exacerbated by the offloading of responsibility for many social programs by federal and provincial governments onto local tax bases. Firm failure, while not easily quantifiable in terms of lost investment to the community, can clearly place local communities at risk. The principal interest of these stakeholders arises from a multiplier effect associated with either an insolvent corporation's continued existence or liquidation.59 Thus, the nature of investments by local government runs along a continuum of fixed and equitable claims, just as those of workers. Local governments have intervened only infrequently in restructuring processes, and often only to protect their direct capital claims. They have only recently realized that there is enormous potential for them to seek party status in restructuring proceedings and to contribute to development of a turnaround plan. On a larger public policy scale, the state may have an interest in the availability of a successful workout regime that allows for enhanced economic activity and reduces the burden on the state from externalized costs of firm failure. The government's pension authority inter-

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vened in Algoma Steel's 2001 CCAA proceeding, discussed in chapter 5, because the unfunded pension liability would ultimately be the responsibility of the provincial government. The state might also intervene as agent where there is an environmental remediation issue in a particular CCAA proceeding. However, aside from acting in this type of role, it is unclear that the state has a direct role to play in a particular CCAA proceeding, unless it has an identifiable economic interest or is acting as agent for particular stakeholders who cannot represent their own interests because of information asymmetries and collective action problems. The scheme contemplates that the court is the branch of the state with responsibility to ensure CCAA proceedings are meeting the statutory objectives. The court's role is to exercise supervisory authority, including ensuring that the requirements of the statute are met, and, as discussed in the next chapter, to meet the statutorily prescribed 'fairness and reasonableness' requirements. This is part of the separation of powers contemplated by our constitutional scheme. If the state wants to intervene, in the absence of direct or representative economic interests, the appropriate forum is the legislative process, not the courts. As is evident throughout this book, while the court advances the public policy objectives of the CCAA in its determination of issues, the larger role of providing direction on public policy in insolvency law is properly situated in Parliament. The state probably does not have a separate interest in appearing as a party in a specific proceeding to advocate a particular result in the name of advancing public policy. The interest of the state, however, might be expanded to include recognition that the state, in the form of local, provincial, or federal government, may have an interest in acting as agent or mediator in order to protect the economic interests of stakeholders who would not otherwise have access to the process. Canada may differ from its neighbour to the south in that local and provincial governments were for many years viewed as guardians of the social welfare state and historically played an active role in the development and protection of social safety nets, the protection of quality of neighbourhoods, and in environmental protection. Governments intervened on behalf of the collective interests of the community. However, this role declined with the election of more conservative elements at all levels of government and the resultant privatization of public services and elimination or offloading of social welfare measures onto regressive property tax bases inadequate to support them. Local governments may

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not have the resources or the public will to participate in restructuring proceedings, and representation of community interest may increasingly have to come from community organizations or coalitions of interest that form around a particular insolvency, such as the Community Action Team that was active in the first Algoma Steel restructuring (see chapter 5). A further question is whether the interests of the state are higher in CCAA proceedings involving firms located in one-industry or resourcebased towns or cities than where firms fail in large cities with diversified economic activity. The impact of firm failure on a community dependent on a single industry is likely destruction of that community. As discussed in chapter 6, the failure of the Anvil Range Mining Corporation affected 20 per cent of the Yukon domestic economy. The Yukon government thus had a direct interest in trying to mediate a resolution, and failing that, in devising a plan to deal with the environmental remediation issues. Participation by the state can be vitally important to the workout process. Yet there is a competing tension when the public interest shifts from vulnerable stakeholders, the employees, and community members of the single resource town to engage more directly with the interests of senior creditors. If a viable workout plan is not established in a timely manner, the realization potential for secured claimants can rapidly decline. The recent case of Skeena-Cellulose in British Columbia highlights the extraordinarily difficult role of the courts in balancing the interests of stakeholders, including local governments, during a CCAA proceeding.60 In larger, more economically diverse communities, the potential role of the state is less clear. For example, it is difficult to see how the interests of the state, other than its own economic interests, were engaged in the Eaton's CCAA proceeding. Eaton's retail operations generally affected stores in urban centres with a large and diversified economic base. While there may be a larger policy question involving lost jobs or the inadequacy of employment standards legislation in terms of protection for workers displaced by firm failure, these are matters more properly for the legislative process. In some cases, the interest of the state arises because of the nature of the service provided by the insolvent corporation. The failure of Canadian Airlines, one of Canada's two principal airline companies, is a good example. In that case, the state had an interest in ensuring that alternatives in air transportation were available in order to protect the public interest in safe, affordable, and accessible transportation.

94 Creditor Rights and the Public Interest Local Trade Suppliers

Local trade suppliers have traditionally been recognized as creditors in insolvency proceedings. However, they can have interests beyond their fixed capital claims, particularly in smaller communities. Trade suppliers are voluntary creditors in the sense that they gave credit in exchange for goods, but involuntary in that they have not usually contracted for risk of firm failure. For example, in the original Dylex case, 13,500 direct jobs and an estimated 30,000 indirect jobs were at risk.61 It is not only the trade supplier's direct capital claim that is at risk, its investment in the community and its employees are also threatened. While the capital claims of individual trade suppliers are small compared to those of secured lenders, the percentage of loss on insolvency is comparatively much greater. It is often impossible to diversify risk, to acquire affordable credit insurance or engage in preventive monitoring. Recognition of these interests under the framework proposed in this book may enhance decision making regarding restructuring, given that local trade suppliers are high-value creditors. Tort Claimants Tort claimants are stakeholders whose claims focus on past actions of the corporation. If their claims are roughly quantifiable and there is reasonable certainty that a claim exists, courts have recognized these claimants as creditors within the meaning of insolvency legislation. Tort claimants are implicated in the public interest framework because of the public interest in compensating those harmed by corporate activities, the interest in crafting remedies that create incentives to prevent further harms, and an interest in how the restructuring accounts for and apportions responsibility for their claims. The claims in question may or may not be easily quantifiable, and they may not be fixed in terms of harm, costs to health, and other common law damages. In the United States, in cases such as Dow Chemical and Johns Manville, the courts recognized tort claimants as creditors, accorded them rights in reorganization proceedings, and included settlement of their claims as part of the workout. As described in the discussion of Canadian Red Cross (chapter 7), Canadian courts have followed suit in according tort claimants participation rights. However, as the discussion in chapter 9 will illustrate, while the satisfaction of tort claims through trust funds set up in restructuring

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proceedings can enhance timely resolution of complaints, it can have negative consequences as well. It can encourage multiple litigants without concern for the seriousness of harm inflicted; the amount set aside in trust funds may be inadequate for the satisfaction of future claims; and future tort claimants may be bound inappropriately. Tort claimants, moreover, do not necessarily have an interest in the future of the insolvent corporation. Consequently, they have little incentive to negotiate a viable restructuring plan unless persuaded it will generate considerably more than the immediate liquidation value of their claims. The Nature of Community and Other Stakeholder Interest All of the stakeholders described above comprise part of the 'community' affected by a firm's financial distress. Depending on the economic activity of the insolvent corporation, other elements of community may also have an interest in the restructuring proceeding. For example, a local community or ratepayers group may have formed in reaction to the contamination of local water or property. Individuals in such groups may have individual capital claims against the corporation; as a group, they may also have an interest in future land use or in the future governance of the corporation such that future harms to the community are prevented or minimized. Similarly, particular consumer groups may have an interest in how a corporation is restructured in terms of adherence to product safety standards or spin-off health effects from continued production uses. An example would be a community coalition formed to deal with the potential adverse health effects of airborne lead contaminants from an industrial complex located proximate to their residential area. Depending on the economic activity of the corporation, its physical proximity to the community, or the risks associated with its product line, different community interests may have an interest in how the firm resolves its financial distress. While that interest may have a fixed value arising out of common law tort or property claims, or consumer, environmental, or other remedial statutory claims, there may also be interests of an equitable nature beyond these contingent or fixed capital claims, because of the community's interest in both future economic activity and reduction in future harms to community. Where stakeholder groups clearly have an interest of an equitable nature, a substantive objective of insolvency law should be recognition of these interests for some of the same reasons discussed with

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respect to workers' interests. Thus, depending on where these nontraditional creditors or stakeholders are situated, they may have claims to participation and/or decision rights in the negotiations for restructuring. Where they have investments in the firm that are at risk, they may have further capital to invest in the restructured corporation in terms of injections of equity, investment through debt forgiveness, environmental liability waiver or other contributions. The interests of such stakeholders may be difficult to quantify, particularly the amount of cost that should be internalized to the insolvent firm. Like workers' human capital investments, these claims present valuation challenges. However, indirect inputs to the firm, such as schools, community infrastructure, or child and elderly caregiving, are measurable, even if in rough terms, and their link to the corporation's generation of wealth needs to be made more visible. This valuation may give rise to participation rights, although the remoteness of these investments is unlikely to give rise to claims that deserve decision or post-workout value, other than indirectly. Participation and decision rights may only be appropriate as a policy instrument where claimants can establish past investments in reliance on future activities of the corporation or future costs from reasonably anticipated environmental clean-up or other costs. One indicium for participation might be whether these stakeholders can contribute useful informational capital to the decision-making process. Tort claimants, as discussed above, whose interest arises out of the past actions of the corporation, may have little to contribute to development of a viable business plan. Clearly, they have enforceable claims that grant them an entitlement to vote on a proposed restructuring plan. However, depending on the nature of the harm, the quantum of their claims, and the present and future ability of the corporation to satisfy those claims, they may or may not have value to contribute in terms of design of a turnaround strategy. In contrast, a particular consumers' group may have a future interest in the standards of product safety that the corporation will achieve as part of its going-forward strategy. For example, in the case of medical products, a consumers' group may be comprised of individuals harmed or affected by the corporation's past actions, but the group as a whole may be principally concerned with the larger public interest in ensuring the business plan protects future consumers. While such an interest would likely not merit formal decision (voting) rights, it may merit participation rights such that these issues or possible workout strate-

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gies are placed before the court, where they can benefit multiple stakeholders and the public interest. Unlike the stakeholders with economic interests in the corporation's future, parts of communities with a more tangential link with the corporation should not necessarily be parties to the restructuring exercise. While both types of interests arguably give rise to the court's consideration of the public interest, the instruments for recognition of these claims may not necessarily include participation and decision rights. Karen Gross has suggested a twofold test in which to recognize the interests of community. First, the community must establish that it shares an 'identifiable nexus' with the debtor corporation, whether on social welfare or economic grounds. Second, the community must establish a 'real and palpable injury' that is capable of being redressed by the court's exercise of equitable jurisdiction.62 These criteria are helpful, particularly if the scheme can provide a timely and cost-effective means of ascertaining the value of the injury. Otherwise, unless parties agree to the involvement of such stakeholders, adoption of this model would place considerable expense and onus on the community seeking participation. It would likely generate considerable litigation, as parties seek to resolve disputes about the nature and quantum of claims. The costs incurred in taking such community interests into account may exceed any merit in the exercise, given that the transaction costs of a court-supervised restructuring are already high. There must be a cost-effective means of participation or it may not be viable. Yet to limit participation to those who have fixed claims might eliminate the participation of stakeholders whose fixed claims have been satisfied, but who have equitable claims such that their participation is warranted. If a government or local community or consumers' group is acting in a representative capacity to protect the interests of particular stakeholder groups with fixed capital claims, it is the measure of the economic interest of these stakeholders that establishes that group's interest in being before the court. In such cases, there would be no necessity for the costly exercise of establishing interest. Any move to recognize the types of interests and investments discussed here first requires acknowledgment that some adjustment costs as a result of these losses are the responsibility of the corporation, given the investments that parties have made in the firm. It requires recognition that such costs should not be borne exclusively by governments or communities. In this context, the nexus of interest approach

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makes sense. However, given that valuing existing inputs more carefully would have distributional consequences, such recognition is likely to be strongly opposed by secured creditors. They would argue that consideration of these interests would detract from the creditor wealth maximization model, and thus from the amount that they will realize ex post the CCAA proceeding. This objection is answered if one endorses an objective of enterprise wealth maximization. Moreover, in some circumstances, it may be that the 'community' has nothing further to offer if the equitable investments of workers, suppliers, consumers, and local governments are more fully recognized. As will be illustrated in chapters 5 to 8, Canadian courts are increasingly willing to recognize and accord participation rights to non-traditional creditors, whether their claims are contingent or not. In some cases, that recognition has included funding representative counsel for non-traditional stakeholders out of the remaining assets of the corporation, in order to make their participation rights meaningful. Generally, however, courts have granted this recognition only where there are quantifiable or established capital claims on the corporation's assets. Rarely do they recognize investments further along the continuum. Alternative Strategies for Recognition of Equitable Interests If the court cannot be persuaded to accept a quantifiable equitable interest as a claim under the existing statutory language, there are alternative strategies to ensure that these interests are before the court and part of its consideration of issues in a CCAA proceeding. Where parties have an interest in a restructuring proceeding and yet do not possess the fixed capital claims that would ensure that their views come before the court, they could seek intervenor status. For example, the Ontario Rules of Civil Procedure provide for two forms of intervention. A non-party may seek leave to intervene in the proceeding as a party, on the ground that she or he has an interest in the subject matter of the proceeding or in its outcome.63 This rule envisions that the intervenor may become involved in the fact-finding process. Alternatively, the rules allow a party to seek leave to intervene in a proceeding as a friend of the court (amicus curiae) for the purpose of rendering assistance to the court by way of argument, without becoming a party. Under these rules, the court has generally allowed such interventions to permit a person to protect an interest that might be adversely affected; or where a particular perspective might not other-

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wise be presented, or where there is a likelihood that the party seeking intervention can make a useful contribution to the resolution of the proceeding without causing injustice to the immediate parties.64 The status of amicus curiae in proceedings has a long history and is generally restricted to those cases in which the court is in need of specialized assistance.65 Thus, where the equitable claims of local communities, consumers' groups, or other stakeholders are such that they might meet the test for amicus curiae standing, intervention on that ground is a viable means to seek to have those claims considered by the courts. Given the courts' express finding that the public interest is to be considered in restructuring proceedings, this status would likely be granted in the appropriate case. Intervention as amicus curiae would involve participation as opposed to decision rights to achieve the objective of recognizing interests in the firm. Such participation rights must be accompanied by extensive disclosure by the debtor corporation, and where appropriate, funding that ensures the meaningful participation of these stakeholders in the process. Currently, creditors' committees are funded or partially funded out of the residual assets of the corporation.66 The policy rationale is that if creditors are ultimately to have their claims deferred, compromised, or converted, they should not bear the entire cost of the process to work that out. Given that stakeholder claims are likely to be deferred or compromised, they too should not be required to bear the entire cost of their participation. Moreover, the court has held that it depends on the parties, including creditors' committees, to monitor the situation during negotiations for an acceptable plan.67 In some cases, community groups or other stakeholders may have important inputs to contribute to a committee that is trying to devise a going-forward strategy. The addition of non-traditional creditors or representative counsel on behalf of broad numbers of stakeholders may provide a cost-effective means of monitoring the debtor corporation and facilitating negotiations for the workout. Ultimately, the court's consideration of stakeholder interests is likely to be of greater benefit to all investors of debt, equity, and equitable capital if a quantifiable value of their investments, and thus a substantive measure on which the court can balance prejudice and interests, has been established. Even where the investments cannot easily be quantified, parties seeking relief should be prepared to present the court with evidence of the extent of stakeholder interest, and the actual or potential social consequences concerned. An example is that

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provided by the liquidation analysis of the Monitor in Canadian Airlines, discussed in chapter 8. Presentation of such evidence would enhance fairness in the process for both existing creditors and the expanded notion of creditor or stakeholder. Enterprise Value Maximization as a Substantive Objective of Insolvency Law One of the most controversial debates regarding the objective of insolvency law is whether decisions in the public interest impose losses on those with expectation of repayment, specifically, on secured and senior creditors. Our current scheme of debt collection already allocates costs and benefits through the existence of statutorily imposed priority of payment, reflecting public policy regarding both the need for a supply of credit at a reasonable cost and the inability of some claimants to contract for risk of loss. In restructuring, the regime distributes the costs of default and the benefits accruing among stakeholders. Given the competing interests and objectives during insolvency, shareholders and traditional creditors have incentives to seek to maximize their claims, regardless of possible adverse consequences to enterprise value or other stakeholders. Secured creditors may have the largest stake in the outcome of the decision, and they may not necessarily advocate enterprise wealth maximization if their claims will be satisfied through liquidation. Yet these creditors have powerful bargaining rights and absent their support, a workout plan will not receive the requisite statutory threshold for approval. Corporations generate wealth for the enterprise by maximizing production and generating consumer and product surplus value. This wealth creation includes generating a greater return to investors than would occur if their capital were invested elsewhere, including the investments of secured and other creditors. If the value generated exceeds external costs to the corporation such as interest payments to creditors, then the corporation is creating surplus value. This notion of wealth creation differs from a simple shareholder wealth maximization objective because it measures wealth creation across all of the investors. It is generally accepted that enterprise wealth maximization occurs where complex relationships among stakeholders interact in a cost-effective, productive, and innovative manner. But where some believe it can be effectively created through contractual relationships, others suggest that it can be optimally accomplished only through

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governance mechanisms that directly account for the at-risk investments of all parties. The adoption of an objective of enterprise wealth maximization flows neatly from recognition of diverse creditor and other interests. Enterprise wealth maximization as a substantive objective of insolvency law can be effected under current insolvency and corporations statutory language. It necessitates recasting statutory obligations to 'act in the best interests of the corporation' to reflect more closely that explicit language. In other words, rather than define that best interest as the interest of shareholders for the solvent corporation and the interest of secured creditors for the insolvent corporation, 'best interests of the corporation' would have regard for all those with investments at risk in the corporation. It would necessitate a clearer delineation of those costs of firm failure that the debtor corporation should reasonably bear and those that should be externalized. Adoption of an enterprise wealth maximization objective would benefit greater numbers of stakeholders. Creditors benefit from a viable restructuring plan that increases the likelihood that their claims will be fully satisfied. Where the workout involves conversion of debt to equity, creditors could also benefit from any value generated over and above existing fixed claims. Adopting enterprise wealth maximization as an objective could also enhance governance of the firm, because those with investments at risk would have greater incentive to cooperate and facilitate decision making. This could minimize free-rider problems and control transaction costs. It could encourage efficient production through enhanced use of informational and organizational capital, reduced information asymmetries, and reduced agency costs. Directors should maximize enterprise value independent of what particular shareholder or creditor groups would advocate: in turn minimizing losses associated with financial distress and reducing the overall cost of capital. Directors to Act in the Best Interests of the Corporation Having Regard to the Investments of All Stakeholders Adoption of an enterprise wealth maximization objective requires a mechanism to ensure that managers do not simply become unaccountable. This is accomplished by recasting fiduciary obligation to take account of all those with investments in the firm, including shareholders, secured and unsecured creditors, workers, and other stakeholders with equitable investments.

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The concept of fiduciary obligation arose as an equitable concept, imposing certain duties of loyalty on individuals who have undertaken, either expressly or implicitly, to act on another person's behalf. Remedies for breach of fiduciary duty are aimed at correcting harm to persons to whom the duty is owed. Existing notions of fiduciary duty have been shaped by both statutory restrictions and judicial interpretation of fiduciary responsibility. The duty also arose as a mechanism to resolve problems of incomplete contracts. In the corporate context, directors and officers are obligated to act in the best interests of the corporation, defined narrowly as shareholder wealth maximization. Much of the governance debate has addressed the accountability gap between managers and shareholders and the mechanisms required to align the objectives of shareholders and managers while controlling agency costs associated with monitoring and accountability.68 Normative assumptions that directors are exclusively accountable to shareholders in terms of wealth maximization have been bolstered by the provisions of corporate and securities statutes that legislate requirements for accountability to shareholders in the solvent corporation.69 In addition, remedial statutes provide creditors, employees, and the community with remedies against behaviour considered contrary to public policy.70 This regulatory scheme has a profound effect on our economic system, and on how corporations and stakeholders contract and interact.71 The shareholder wealth maximization paradigm breaks down when the corporation becomes insolvent. While the loyalties of directors and officers are often still rooted in a shareholder-centred notion of the best interests of the corporation, there is little or no shareholder equity remaining. Creditors, particularly secured creditors, can lay claim to value from the residual assets of the firm, yet their interests are often not taken into account by directors and officers of the insolvent corporation, other than in the narrow sense of settling fixed claims. Yet the creditors have become the residual claimants. There is now an expectation that if they are to continue to invest, the value of their claim should be enhanced on a successful turnaround of the corporation, such as a right to participate in future profits through preferred shares or other incentives. This requires a shift in wealth maximizing objectives away from a shareholder-centred model. Current theoretical approaches to governance of solvent corporations ignore the normative implications of defining efficiency solely in terms of shareholder wealth maximization. Preservation of private

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property, maximization of shareholder wealth, and efficiency goals are deeply embedded in our collective consciousness, and thus they are rarely articulated as normative concepts. Yet their invisibility does not render their content non-existent.72 For example, the contractual relations discourse assumes as a normative starting point that the owners of capital are free to externalize the costs of injury or adjustment from restructuring. It is possible, however, to supplement the underlying normative context in which corporations operate with concurrent objectives arising out of credit, human capital, and other equitable investments in the firm. Just as maximization of shareholder wealth is a normative choice, so, too, there should be a normative assumption that, by virtue of their investments in the firm, workers, local trade suppliers, and other stakeholders may be entitled to protection from, and remedies for, particular harms inflicted by the corporation or its managers on their investments. For example, maximization of shareholder wealth as a normative benchmark for corporate success could be balanced with goals of equity in employment, safe workplaces, and safe product standards. These objectives can be justified on efficiency grounds, if efficiency is recast to encompass an objective of enterprise wealth maximization and an interest in the longterm viability of the corporation and not limited to enhanced shortterm shareholder value.73 Canadian courts have recently moved in the direction of recasting fiduciary obligation on insolvency, finding that directors are to take account of the interests of creditors in discerning l^est interests of the corporation.' Courts have also granted creditors remedies under oppression provisions of corporations statutes.74 Both of these mechanisms should be available to stakeholders to enforce claims against the directors of an insolvent corporation. Just as the courts have intervened to rectify oppressive conduct on behalf of shareholders and traditional creditors, protecting their interests in terms of their reasonable expectations, so too could the judiciary assist in setting the parameters of the obligation to workers, local suppliers, or communities as equitable investors in terms of their reasonable expectations. The current language of corporations statutes allows for such an expansion of fiduciary obligation; however, absent legislative direction, the courts may be reluctant to import such notions into the law. The exception may be in cases where the fixed claims of workers are of sufficient value that the court will react to conduct that is oppressive or unfairly prejudicial to workers' interests. As with current beneficiaries of the

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oppression remedy, courts would only interfere with business decisions when directors act in a manner that is oppressive, unfairly prejudicial, or which unfairly disregards the complainant's interests. In contexts other than corporate law, the courts have been expanding definitions of fiduciary obligation to encompass a variety of relationships. A fiduciary duty is now recognized where the individual has scope for the exercise of power or discretion, where he or she can unilaterally exercise that power or discretion so as to affect the beneficiary's practical or legal interests, and where the beneficiary is particularly vulnerable to the fiduciary holding the power.75 While there is some debate as to whether the court requires an undertaking to have been made, the evidentiary hallmarks for identifying a fiduciary duty include discretion, influence, vulnerability, confidence, and trust. The Supreme Court of Canada has held that breach of a fiduciary duty can arise in reliance-based relationships and can involve nothing more than the inadvertent failure to consider the best interests of the beneficiary, particularly where there is an imbalance in power.76 Arguably, many of these elements are present where the firm is approaching insolvency or is insolvent. For example, applying the court's criteria to workers, managers by virtue of their residual management rights have considerable scope for the exercise of discretion or power over workers' investments; that power can be exercised unilaterally to affect their interests, except where a collective agreement or statute has limited that exercise; and workers are particularly vulnerable to the exercise of managers' discretion, given their inability to reduce risk of loss of their human capital investments. While fiduciary obligations of directors and officers must reflect an expanded notion of decision making that takes account of multiple investments in the firm, this is not to suggest that the best interests of the corporation should merely shift from a shareholder-centred paradigm to a creditor-centred paradigm at the point when the corporation becomes insolvent. At that point, the interests of stakeholders have already been seriously compromised. If governance of solvent corporations takes account of all investments at risk in the firm, then effective governance could act to prevent insolvency. Accountability to and participation by creditors and other stakeholders in the appropriate circumstances could enhance decision making in advance of insolvency. Clearly, decision makers need to be able to determine the scope and application of their fiduciary obligation and thus their liability expo-

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sure. This determination would likely have an impact on the cost of director and officer insurance. Similarly, lenders need to know, prior to giving credit, what other enforceable claims may exist, in order to make appropriate determinations of risk, interest, and monitoring costs. While such claims would rank as unsecured claims and thus still be subordinated to secured creditors' interests, a clear understanding of both the fixed capital claims and present value of stakeholder interest would allow for more informed decision making not only at the point of insolvency, but hopefully, well in advance of financial distress. A more codified recognition of the public interest would have market implications. For example, credit costs might ultimately be higher or future lending activity might be detrimentally affected. Alternatively, if senior creditors gain a more precise understanding of liability to various stakeholders, rather than just a nebulous sense that the public interest may be taken into account, this knowledge could actually enhance credit decisions. A parallel analogy can be drawn from current requirements by lenders or investors to calculate the present cost of future pension or benefit liability. It is critically important that creditors are able to assess the risk associated with application of recognized and valued enforceable claims in advance of granting credit. Creditors are then are able to determine whether or not to provide financing for operating or expansion costs, or for interim or long-term financing during an insolvency restructuring. Secured creditors already influence the governance of corporations because of the covenants they negotiate in their various debt instruments. However, there are few mechanisms through which these creditors can gain decision rights when the firm first begins to experience financial problems. Absent the willingness of the debtor corporation to cooperate privately, the creditor must wait for certain default events before it can take action which ultimately gives it a role in governance or negotiations for a workout. Similarly, absent corporate governance reform for other stakeholders, there are few avenues to influence corporate decision making. Arguably, an expanded notion of 'best interests of the corporation' could create accountability problems, because directors could justify any decision based on some sort of stakeholder interest. This criticism has been made of the 'constituency statutes' in the United States, which provide that directors can consider the interests of constituencies other than shareholders.77 The problem can be remedied by according traditional creditors, workers, and other equitable investors the right to

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challenge decisions based on fiduciary obligations under corporations statutes. The thresholds set by the courts vis-a-vis fiduciary obligation to shareholders and deference to business judgments could then be applied to these other parties. In turn, this could enhance governance of the corporation. The obligation of directors to maximize enterprise value could also reduce the cost of capital by lowering the agency cost of debt, because it lowers the risk of shareholder and manager opportunism, and thus both monitoring costs and risk of non-payment. Principles for Reconciling Traditional Creditors' Rights with the Public Interest A key question that follows from affording much broader consideration of interests is how to reconcile these interests with existing creditor rights. 'Public interest' is a nebulous and troublesome concept. Judicial pronouncements to date have largely avoided defining the public interest, although it is increasingly used as the rationale for particular decisions. In the context of insolvency law, reference to the public interest is essentially a short form means of communicating the complex balancing of diverse interests that the courts undertake. Arising from this balancing and from the collective experience of insolvency proceedings over the past decade, the courts have distilled several principles that are in the public interest. These principles can be summarized as follows. It is in the public interest to avoid premature liquidations, and restructuring schemes are a valuable mechanism to prevent them. It is in the public interest to achieve the optimal allocation of costs of firm failure, internally and externally. It is in the public interest to protect the claims of various stakeholders such that there is not a race to enforce individual claims to the detriment of other claimants. It is in the public interest to respect the statutory allocation of priority of claims while still allowing parties the opportunity to determine whether they should compromise or defer those claims in anticipation of generating greater value in the long term. It is in the public interest to enhance access to information about the insolvent firm in order to allow for informed negotiations for an optimal solution. It is in the public interest to generate economic activity and to create a going-forward business strategy that preserves creditors', workers', and other firm-specific economic investments. 'Public interest' is the short form for referring to all of these interests. Complex relationships, multiple remedial statutes, and interests beyond traditional creditors and shareholders are all part of the public

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interest. As one scholar observed more than fifty years ago in discussing the then-new CCAA, the court in rendering an informed judgment must make an equitable judgment considering all of the interests involved in the firm, because restructuring involves interests beyond shareholders and creditors, including workers, minority creditors, and the public.78 Once this is understood, the question is how to ensure that the framework for decision making both protects and reconciles traditional creditor and other stakeholder interests. The framework proposed in this chapter does not require any statutory amendment. There are, however, some basic principles for reconciling stakeholder interests. First, the plan needs the support of traditional creditors, because of the financially distressed corporation's need for new capital to carry on operations and because of the statutory voting requirements. Thus, creditors' rights are preserved. Second, the existence of substantive rights under the insolvency and bankruptcy statutes gives traditional creditors considerable bargaining power, even in a process that recognizes multiple interests. The statutory stay provision acts to temporarily suspend enforcement rights of creditors. It can also be viewed as a temporary suspension of control rights, affording more opportunity to obtain and effectively use informational capital from those stakeholders who are equitable investors. Finally, definitions of class can be used to accommodate a spectrum of participation and voting rights. Few would dispute the fact that any systems approach to insolvency must continue to protect the rights of traditional creditors and respect the overall scheme of bankruptcy that creates a priority in the enforcement of claims (although the precise order of priorities is legitimately the subject of considerable debate, and any changes to this order are properly the subject of legislative amendment). This scheme allows parties to undertake risk assessment and investment decisions with some certainty about their rights and priorities on firm failure. It preserves incentives to lend money and thus ensures the future availability of credit. In turn, this will prevent premature liquidation. Obviously, this framework has some distributional consequences. However, the existing regime, by valuing some firm inputs and not others, likewise has ongoing distributional consequences that must be recognized. Whether or not a firm is insolvent, the current regime values equity and debt capital to the exclusion of other investments. These normative choices must be made visible so that one can make informed decisions about which distributive model is to prevail. Any distributive consequences would be based on quantifiable investments

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made by stakeholders in terms of human capital, environmental waiver, or capital investment in infrastructure. These investments have always existed but are not fully accounted for, resulting in harmful distributional consequences in the workout process. It is these current distributional consequences that require correction, if the system is to fully value claims arising out of firm-specific investments. Recognition of these interests would likely track the development of the law in terms of the first recognition by the courts that creditors have interests beyond their fixed capital claims at the point of insolvency. At that point, creditors have become the residual claimants, and their interests, as noted as the outset of this chapter, are complex and diverse. On insolvency, a debtor corporation that decides to attempt a workout, applies for the protection of the court, and an initial stay is granted with approval of the court in a CCAA application. Creditors' rights to enforce claims are temporarily suspended during the stay period so that the debtor corporation can direct its resources towards development of a restructuring plan instead of proceedings in which creditors seek to enforce their claims. Ultimately, the statute requires substantial support by the creditors if a plan is to be sanctioned by the court. If a restructuring is likely to result in creditors receiving more than the value they would receive if the corporation were liquidated immediately, the first threshold in the restructuring process has been crossed. Beyond that, however, the framework contemplates high buy-in from the creditors of any proposed plan. Creditors must determine that the forgone liquidation value (whether it is asset based or a going-concern sale) is likely to be worth the restructuring, possible revitalization of the firm, and future satisfaction of their claims. The framework advanced here does not substantially injure the rights of traditional creditors. Creditors would continue to have the right to vote for or reject a proposed plan. Failure of the debtor corporation to secure support for its plan in the amount specified by the legislation would result in the failure of that plan, and most often in receivership proceedings, allowing creditors timely enforcement of their claims. Recognition of greater stakeholder participation would require some additional transaction costs, as the negotiations would involve more parties and more interests. Creditors may indirectly bear the costs of the workout, as the corporations' resources are directed at restructuring instead of satisfying claims, but this cost may be offset by the value ultimately generated by implementation of an effective plan. All parties may ultimately profit from a restructuring plan that has the

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benefit of more informational capital and high support from workers, trade suppliers, and local governments. The framework imposes on the debtor corporation a number of obligations to ensure that creditors' interests are not prejudiced during the stay period, reinforcing the larger scheme and hierarchy of secured transactions. Bankruptcy and insolvency law permit the registration and enforcement of creditors' claims in a regime in which they are given specific priority, both in and outside of bankruptcy. Creditors' rights continue to be preserved. A further question involves weighing the costs of negotiating any surplus generated by a successful workout against the benefits, necessitating some sort of assessment of the costs and benefits of a negotiation process to ensure that the assets, broadly defined, are put to their best use. This exercise is already undertaken by senior creditors and it would continue, factoring in the costs and benefits of expanded stakeholder participation. The highly inefficient corporation, which has no chance of survival, should not survive. This is not the purpose of insolvency law. The costs of negotiating a restructuring plan should be part of a determination of whether to proceed or not. However, the determination of whether a firm should survive is multi-dimensional and involves interests beyond those of traditional creditors. It is not purely a question of whether the corporation is worth more to creditors in their own hands or in the hands of third parties. It involves considerations of where the corporation is situated, available product and capital markets, the impact of failure on communities, maintenance of client/consumer preferences, goodwill, the activism of workers, and a host of other economic and social considerations. The decision should be based on an assessment of competing uses of corporate assets in order to find the optimal outcome. Moreover, the range of stakeholders with investments at risk may have everything to do with which solution will generate the greatest return to satisfy the claims of creditors. For example, workers, trade suppliers, or local governments, as high-value creditors, may have the greatest incentive to try to negotiate a workout, because the potential economic loss on firm failure is far greater for the community than their fixed claims would indicate. The long-term losses to jobs, community stability, and municipal tax bases are not measured in a simple debt collection regime, nor does such a regime take account of the incentives for these stakeholders to enhance the performance of the corporation to ensure that it becomes viable again. Senior creditors do

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occasionally acknowledge these factors without in any way compromising their ultimate rights to enforce. If these creditors can recognize the value of stakeholders' past and future contributions to the firm, they may recognize a congruence of interest. Given that the hierarchy of claims is largely preserved, the recognition of participation and decision rights of these equitable investors does not substantially harm traditional creditor rights. One legitimate criticism is likely to be that different assignments of value of investments in and out of insolvency or bankruptcy regimes should not be made, because of the danger of deferred liquidation or forum shopping. This concern could be resolved by ensuring that 'besi interests of the corporation' is cast as maximizing enterprise value in the manner suggested above, whether or not the firm is insolvent. Consistency in and out of bankruptcy would prevent opportunistic behaviour, but it would also require shareholders to relinquish their current primacy in governance. Given the strong normative underpinnings of the current corporate law regime, this would be a more fundamental shift, and this question is currently very much part of the governance debate. In the interim, the reasons for according recognition to non-traditional stakeholders' investments in insolvency is compelling, given the disproportionate ability to contract against risk of firm failure and the inequitable losses consequently borne by equitable investors. The Role of the Judiciary in Reconciling Differences Just as the courts' current role involves reconciling the interests of traditional creditors with those of managers and shareholders, the courts have an important role to play in the reconciliation of differences in the insolvency framework proposed here. The restructuring scheme must facilitate incentives for parties to develop and agree on plans that serve their economic interests. The role of the courts is to ensure that the interests of diverse stakeholders are recognized and considered, not to dictate the outcome in any particular proceeding. The courts' role in this respect involves both procedural and substantive decision making, often with considerable overlap between the two. Much of that role is already undertaken in our current insolvency regime. The difference is that the courts would facilitate the creation of a process to take into account investments and assets that have not traditionally been valued. Then it is left to the stakeholders, broadly

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defined, to negotiate and vote on a restructuring plan or proposal. Concerns have been expressed that the regime currently accords too much discretionary power to the courts, an issue canvassed at some length in the next chapter. Yet the experience of the scheme suggests that the courts' role has not been overstepped. Unlike typical commercial litigation, where proceedings are adversarial and the court is engaged in ex post rights determination, in insolvency proceedings, the courts act in a supervisory capacity, facilitating negotiations between the parties and applying statutory criteria when asked to do so. Where the statute does not afford guidance, the courts determine disputes having regard to the objectives of the legislation. Moreover, the court will not approve a proposal that does not garner the support of a substantial number of creditors. The court's task in sanctioning a particular restructuring plan is to ensure that the statutory requirements have been strictly complied with, and to determine that the plan is fair and reasonable.79 The 'fairness' inquiry, discussed in some detail in chapter 4, has involved a balancing of interests. Here, the inquiry would be expanded to include a balancing of equitable investor interests in addition to the more traditional creditor and shareholder interests. It is not the role of the courts to secondguess business judgments. However, these judgments are currently measured against a normative benchmark of maximizing shareholder interests for the solvent corporation and maximizing creditor value for the insolvent corporation. Yet the benchmark for assessing business judgment could be made enterprise value maximization, as discussed earlier. Key issues then become who has participated in determining the business decisions, and how investor interests have been considered in decision making regarding the workout. Currently, judicial assessment of the fairness of a plan is an assessment of whether the interests of creditors as the new residual claimants have been met, recognizing the shift in interest and a balancing of equities in terms of the impact of particular decisions.80 This assessment would be enhanced by consideration of the equitable residual interests of stakeholders with investments at risk on firm failure. In creating a process that more explicitly recognizes the equitable as well as fixed capital claims of investors, the courts can make a number of procedural and substantive orders. They can order particular participation and decision rights, by determining classes under the CCAA, including determination of similarity of interest. They can order disclosure, to reduce information asymmetries. The courts may be re-

112 Creditor Rights and the Public Interest

quired to set timetables for interim decisions in order to ensure an expeditious resolution of the process. Through the granting or refusal of continuation of stay periods, the courts can ensure that workers, local governments, tort claimants, and other stakeholders are participants in the process. The courts can address the issue of resources to participate by granting requests for the funding of representative counsel. Structuring of creditors' committees can ensure that broader interests are accounted for and enhance monitoring, as well as facilitate greater buy-in by stakeholders of any plan ultimately developed. The courts can authorize payments for professional advice, thus reducing the transaction costs for parties trying to participate on their own and ensuring more informed decision making by all stakeholders. They can set out cost sanctions for any bad faith efforts by parties in negotiations for a plan. They can order a variety of dispute resolution processes in order to contain costs and expedite the workout process, or utilize their own mediation skills in resolving issues between senior creditors and other stakeholders. Through development of case law, the courts could provide templates or menus that would assist stakeholders who are new to the insolvency process, or who are less sophisticated, to understand the scope and possibilities for their participation and decision rights. The courts could utilize their appointed officers, such as monitors and receivers, to perform tasks such as information reporting, development of restructuring plans, or mediating conflicts between investors, having regard for all of the investments at risk in the corporation. Thus the role of the judiciary would be to continue to facilitate the objectives of insolvency legislation by ensuring a timely and informed resolution of issues in dispute between the parties. At the end of the day, if the senior creditors are not persuaded by the merits of a proposed plan, and if the debtor corporation is not able to garner the requisite support, the scheme allows creditors to move to enforce their claims. Ultimately, the success of a restructuring can be measured by whether a greater flow of profits to investors has been generated by the restructured debtor corporation than if they had invested elsewhere, including debt, equity, and equitable investments. The framework supports the existing creditor approval provisions of the statutory scheme. It merely requires that before that determination is made, there should be a full consideration of the costs, investments at risk, and restructuring potential of the insolvent corporation.

4 Judicial Discretion under the CCAA

The [CCAA] plan represents the fragile balancing of a myriad of commercial factors - with each participant in the process "giving and getting" a complexly interwoven and, in some ways, indefinable exchange of economic interests.' Mr Justice Blair, Olympia & York '

Judicial consideration of the public interest is a continuous theme in CCAA proceedings, but it is most evident in four key parts of the process: granting of the stay, DIP financing decisions, determination of classes, and sanctioning of the plan. This chapter examines the application of the theoretical framework set out in chapter 3 to the current statutory scheme. It explores whether the courts are engaged in purposive interpretation or overreaching their jurisdiction. Examination of key disputes decided by the court reveals that judicial interpretation has encouraged conduct that furthers the objectives of the CCAA while respecting the statutory hierarchy of creditor rights. Recent judicial recognition of the public interest has set the stage for a more fulsome consideration of governance of the insolvent corporation. The chapter then examines the procedural tools used by the courts in the process, and the role of court-appointed officers in respect of public interest considerations.

114 Creditor Rights and the Public Interest Judicial Recognition of the Public Interest

There are three principal differences between a private workout and a CCAA court-supervised proceeding: cost, control, and public interest. The courts have held that the CCAA is broad remedial legislation designed to facilitate a restructuring of debtor corporations in the interests of the company, its creditors, and the public.2 The statutory scheme contemplates that the rights and remedies of various stakeholders might be temporarily sacrificed in the restructuring process. In Quintette Coal, the British Columbia Court of Appeal observed that an important consideration in sanctioning a plan was the public interest in the company's survival, given the significance of coal to the British Columbia economy.3 The courts have observed that the CCAA was designed to serve a 'broad constituency of investors, creditors and employees.' As a consequence, the courts will consider the individuals and organizations directly affected by the plan, as well as the wider public interest, an interest that is generally, although not always, served by permitting a company to attempt a restructuring.4 The CCAA is aimed at avoiding, where possible, the devastating social and economic consequences of loss of business operations, and at allowing the corporation to carry on business in a manner that causes the least possible harm to employees and the communities in which it operates.5 The difference between the courts' public interest definition and the one proposed in this book is largely a function of who is defining the public interest, and how that interest might be quantified. Currently, the parties before the court are almost always the debtor corporation and traditional creditors. Both use the notion of 'public interest' to persuade the court of their position in a particular case. The stakeholders most affected in terms of the public interest - workers, small trade suppliers, communities, and local governments - are often not represented at proceedings. Even where they are represented, it is difficult to establish what the public interest is. This is best illustrated in the Canadian Red Cross case, discussed in chapter 7, where the debtor corporation argued for immediate transfer of the national blood system 'in the public interest' and the tort claimants argued for delay 'in the public interest.' It is difficult to extract a definition of 'public interest' from the extensive case law. Public interest under the current regime is not a substantive objective, but rather a 'short form' for the complex balanc-

Judicial Discretion under the CCAA 115

ing of diverse interests in which the courts engage in determining disputes that arise during a CCAA proceeding and in approving a plan. Consideration of the public interest is one aspect of the court's assessment of the viability and fairness of the proposed plan within the existing statutory scheme of priorities. The courts have held that a broad public dimension must be considered and weighed in the balance as well as the interests of those most directly affected.6 This finding mirrors Andrew Keay's definition, discussed in chapter 2, that the public interest in insolvency law involves taking into account interests which society has regard for, and which are wider than the interests of those parties directly involved in a particular case (the debtor and creditors).7 Michael Rotsztain has pointed out that the court's role is critical in balancing the rights of multiple stakeholders - secured creditors, employees, prospective purchasers of assets, and the community - and this balancing of interests must allow for development of clear, fair, and consistent case law that can be relied on by future parties.8 Purposive Interpretation or Judicial Overreach? Criticism of the scope of the courts' exercise of jurisdiction under the CCAA owes in part to the fact that, prior to the relatively recent utilization of the CCAA as a workout tool, senior secured creditors controlled the workout process and unilaterally determined when there would be a liquidation. With the renaissance of the CCAA, these creditors have suffered a slight loss in control, at least for the temporary period of the stay. Any shift in control gives rise to resistance by those not benefiting from the shift, particularly where those previously in control of the process have the resources to champion their cause. However, notwithstanding these highly politically charged critiques, there are some legitimate concerns that have been raised. The first claim is that the courts have no authority to intervene directly in workout negotiations, and that they have used their supervisory authority to skew the negotiating process through a presumption in favour of restructuring, and, as a result, have explicitly or implicitly favoured the interests of particular stakeholders.9 The judiciary, it is argued, should control its biases and limit its role to one of case management. Ironically, a different critique, one that suggests that the CCAA has been used to effect an organized liquidation that should properly occur under the BIA, comes from the same interests that argue the court is predisposed to restructuring as an outcome. Yet

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the courts' role under the CCAA is primarily supervisory. The courts rarely intervene in negotiations, and where they become involved in mediating resolution of a plan, as in the Algoma Steel restructuring, the judge involved in the dispute resolution process is not the judge who ultimately conducts the plan sanctioning hearing. The courts make particular determinations during the process where the parties are unable to agree. These decisions facilitate the negotiation process, whether it results in a going-concern solution or not. Moreover, the court must be periodically satisfied that the parties are making progress in the workout negotiations. Thus the role is both procedural and substantive in making rights determinations within the context of an ongoing negotiation process. The courts have held that because of the remedial nature of the legislation, the judiciary will exercise its jurisdiction to give effect to the public policy objectives of the statute where the express language is incomplete, including endorsement of a survival program of the debtor corporation.10 A closely tied critique is that the case-managing role of the judge takes decision making out of the realm of the public and thus is unaccountable.11 This ignores the realities of CCAA proceedings. Negotiations between creditors and other stakeholders are largely conducted in private, and the court may encourage various forms of dispute resolution, but judges have consistently declined to deal with matters of rights determination in camera, finding that these matters are more appropriately for public hearing. Judges interpret and apply the legislation to the issues in dispute in the public forum of a hearing, thereby enhancing accountability to all creditors and the public interest. The fact that this requires multiple skills on the part of the judiciary does not render the process biased. Judicial rulings have a substantive component in that they define the framework, determine information or participation rights where parties cannot agree, determine allegations of prejudice, and keep the process moving towards an expeditious resolution. The objective of the statute is to facilitate compromises and arrangements, thus there is a legislative presumption in favour of allowing the debtor to try to negotiate a plan. The courts give effect to this objective. This critique really appears to be one of opposition to judicial reasoning that supports the statutory objectives. While rational people may disagree on the policy objectives of the CCAA, these are matters more properly for the legislative forum. Another critique is that the courts' role should be limited to preserving the status quo during the stay period, and that orders such as priority financing disturb this status quo and are beyond the scope of

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117

judicial authority. While the legislation endorses restructuring as enhancing social welfare, the courts should not assume they have been given direction to assist those favouring restructuring and to silence those who are opposed.12 But Gordon Marantz, a leading insolvency practitioner, has observed that examination of the major cases of the past decade does not reveal substantive grounds for this complaint.13 Moreover, the federal government consultations conducted in 2001-2 indicated that there is little complaint of bias or excessive exercise of judicial discretion under the CCAA. At most, there have been recommendations to legislate principles for the exercise of the courts' discretion.14 At the heart of these complaints conceptually, is the fear that judicial discretion may give rise to individualized decision making. As Karen Gross observes, 'messiness' is an inevitable part of every legal and social system, and the current bankruptcy system is already rife with uncertainty. She supports sufficiently individualized judicial interpretation that acknowledges the inherent complexities and problems of financial distress and the people implicated while respecting the statutory hierarchy and requirements of bankruptcy legislation.15 An increasingly rich scholarship on judicial decision making suggests that, rather than seeking to achieve an impossible standard of objectivity, judges engaged in decision-making processes should interpret and apply legislation while trying to be cognizant of their race, gender, and class biases. While recognition that background influences judging can reduce prejudice inherent in judicial determinations, groups who are not characteristically represented in the judiciary must also be able to place their views before the courts. This is particularly important in insolvency, as the whole regime is structured on the basis that there is not enough current value in the corporation to satisfy all claims and thus any outcome must balance the risks at stake. Without these views being presented, the balance will be struck in the absence of potentially vital information. The third principal criticism made of judicial discretion under the CCAA is that the courts are engaged in a redistributive exercise. The charge is that the shift in recent years towards the courts' consideration of the public interest has had the effect of increasing access to initial stays, and that the courts' consideration of diverse interests frequently justifies allowing the debtor a period to negotiate restructuring, over the objection of a group of creditors who have the ability to ultimately veto any plan.16 Yet the courts have stressed that the stay provisions are time-limited remedies and that any suspension of credi-

118 Creditor Rights and the Public Interest

tor rights to enforce are temporary, absent agreement on a plan. The fact that many stakeholders may initially be in favour of a workout while a few are opposed is not evidence of judicial bias. Rather, the opposition of the few opposed stems from the fact that, absent a CCAA proceeding, they can immediately realize on their claims and thus have little incentive to support the workout process. Since the liquidation value fully satisfies their claims, they resent the time and cost of a process that while it may maximize enterprise value, does not necessarily enhance the realizable value of their particular claims. This endgame approach is in part what the legislation is aimed at remedying. The assumption that the public interest is served through restructuring as opposed to liquidation is also objected to, when a restructuring process imposes significant costs on the operating lender and secured creditors while benefiting other stakeholders. The courts, however, do not always accept as a given that restructuring is more efficient at capturing enterprise value. Parties must present some evidence as to the potential upside value if a CCAA process is allowed to proceed. Closer scrutiny of these criticisms reveals that the principle concern is that there may be some redistribution of value in the restructuring process. Yet insolvency by definition means that there are not sufficient assets to meet debt obligations. Restructuring involves adjusting claims, trading debt for equity, and other arrangements where parties are satisfied that there is potential long-term gain over liquidation. Secured creditors are exposed to some risk of their collateral depreciating during the workout period, although the risks to unsecured creditors are frequently greater. Moreover, senior creditors already adjust for the cost of firm financial distress in their credit decisions, including costs associated with court-supervised workouts. They also have sufficient bargaining power during the CCAA process to win price adjustments in the cost of future financing that account for recognition of stakeholder interest or compromise of their claims. While secured creditors may bear a portion of the CCAA process costs, they will have first call on any benefits to be extracted from a successful workout. The redistribution critique relates back to the discussion in chapter 3. Since the existing regime does not fully or fairly value current inputs into the corporation, it has its own redistributive consequences. If investments are properly valued, the 'redistributive outcome' is really one of according value to human capital and other investments that should have been accorded a value much earlier in the process. In these circumstances any redistributive outcomes from recognizing those

Judicial Discretion under the CCA A 119

interests are really a tempering of the redistributive effects of the current regime, where value flows to capital claimants to the detriment of other kinds of investors. The key questions become how to value claims in a way that fully recognizes investments in the firm and how to value outcomes of a CCAA process in a manner that recognizes interests at stake. Fred Myers and Edward Sellers point out that the litigation process is currently ill-equipped to permit a thorough inquiry into the broad social consequences of a restructuring plan, such that elements of arbitrariness may be introduced into the process by the court.17 They suggest that fairness should extend to both the process and the results achieved and that there should be more evidence before the court when it makes public interest decisions. This is a legitimate criticism. As noted earlier, while stakeholder interest will not always be easy to calculate, it can be undertaken and would provide the court with a more tangible basis on which to assess prejudice to numerous stakeholders, including the senior creditors. Where judges have publicly commented on their role in CCAA proceedings, it is evident that they are aware of the limits of this role and the separation of the judiciary and the legislative process: It is my view that the courts should never be placed in a position or expected to assume a legislative function as contrasted to assuming a procedural function in the absence of specific statutory enactments ... it does not flow from that, however, that simply because one constituent is opposed to a particular reorganization scheme, that the scheme should fail. I perceive the position of the court in such situations to be ensuring that the proposed arrangement is properly considered by all constituents affected, before final approval or rejection is sought. Forsyth J., Alberta Court of Queen's Bench18 We must remember the important and necessary division of powers in a democratic system of government where the judiciary is completely separate from the executive and legislative arms of government. Unless required by law, a judge should not get involved in social and economic issues. Farley, J., Ontario Superior Court19 In exercising their traditional adjudicative role judges must remember that they are judges. Their mandate is not to make political decisions, but to make judicial decisions. On the other hand, judges do not live in a

120 Creditor Rights and the Public Interest vacuum. They are not impervious to the social and economic implications of matters that come before them. In dealing with cases which have a public dimension to them, such as business reorganizations, underlying consequences pertaining to the social and economic impact of the reorganization on the community form the setting in which the court exercises its supervisory jurisdiction over the process ... while the social and economic consequences for the community of the closure or restructuring of a business are not of direct concern to the judge in making her or his judicial decisions, they may well affect the court's response to the processing of the reorganization and its approach to the resolution options. Blair J., Ontario Superior Court20

These comments reflect what occurs in the courts. Judges adjudicate multiple disputes under a restructuring proceeding, interpreting the CCAA and its companion corporations, securities, personal property security, bank, and bankruptcy statutes in light of the specific disputes before them. Canadian courts have been consistent in finding that they will not second-guess the business judgment of parties, but rather will ask questions or make determinations that balance complex and divergent interests and ensure that the statutory requirements have been met. Moreover, where the courts are called on to make decisions and are concerned that particular interests have not been given notice or are not before them, the courts have emphasized that a particular order is subject to the 'come-back' clause, in essence, inviting creditors to seek reconsideration once they receive notice of a decision. Concern has also been raised by debt collection theorists that if there is a different scheme of priorities in and outside of bankruptcy, parties will engage in forum shopping to maximize their strategic position, leading to either premature or deferred liquidation. This is a valid concern. The obvious response, however, is that if investments in the firm of a debt, capital, and equitable nature were recognized at all points in the life cycle of the firm, the need for forum shopping would disappear. This is probably much more controversial than recognizing the primacy of creditor interests on insolvency, but it deserves further study. Use of the Stay Process to Recognize Diverse Interests Unlike BIA proposal proceedings, in which the stay is automatic, under the CCAA, the court must determine whether it is appropriate in

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the circumstances to grant a stay. The courts have held that their task under the CCAA is to facilitate an effective process aimed at compromises and arrangements, and that the debtor must be afforded a respite from litigation during the period in which it is attempting to carry on as a going concern and to negotiate a plan acceptable to creditors.21 Thus the courts have liberally interpreted the stay provisions in order to facilitate the negotiation process. Where a court has granted an initial stay in face of opposition from key creditors, the stay period imposed is often very short, with a fixed date to come back before the court. The debtor corporation must then establish to the court's satisfaction that it has a reasonable chance of successfully negotiating with creditors.22 There is considerable debate regarding the threshold the court should apply to determine whether an initial stay application should be granted. According to the lower threshold the court will grant a stay unless the process is "doomed to failure/ as found by the British Columbia Court of Appeal in Re Philips Manufacturing. The higher threshold requires the debtor to demonstrate that there is a 'reasonable prospect of a viable workout.'23 Careful examination of the cases heard in the past decade indicates that, with a few exceptions, the courts engage in a balanced inquiry at this stage. While the threshold test varies across Canada, in practice, the actual exercise of discretion to grant the stay is reasonably consistent. Given the objectives of the CCAA, a court will generally grant the initial stay unless it finds that the CCAA application is merely an effort by the debtor to avoid its obligations to creditors or that creditors have lost all confidence in management of the corporation. There has been a shift away from granting stays on an ex parte basis, and where ex parte stays are found necessary, the court will only grant them for very limited periods until appropriate notice can be given.24 The debtor corporation does not have to demonstrate at the initial stay application stage that it has a feasible plan. The precise reason for the stay is to afford the company a limited period in which to develop a plan. The courts have held, however, that debtor corporations are well advised to have consulted with major creditors in advance of the request, in order to ascertain their willingness to cooperate in the negotiation of a workout. The British Columbia Court of Appeal in Chef Ready Foods held that the objective of the CCAA stay provision is to provide a protective device, not only for the benefit of the debtor corporation, but also for a broad constituency of stakeholders.25 Even

122 Creditor Rights and the Public Interest

where some secured creditors are initially opposed to the stay, the courts have held that 'all affected constituencies must be considered, including secured and unsecured creditors, preferred creditors, employees, landlords, shareholders and the public generally.'26 These cases indicate a new willingness to consider all interests implicated in a firm's financial distress. Although the stay constitutes a temporary loss of control by senior creditors, as suggested above, the courts are merely giving effect to the legislation. The balance of convenience must weigh in favour of granting the stay, given that the courts will not lightly interfere with creditors and other claimants seeking to enforce their rights.27 One critique of the courts' exercise of the stay power is that the same considerations are applied to creditors whose value is at greater risk as to those most likely to gain upside value through an eventual restructuring.28 This is really an argument for preferred treatment of secured creditors, who enjoy a higher priority on a liquidation scenario. Yet a restructuring proceeding is a step prior to liquidation, expressly aimed at suspending that priority of rights for a limited period to determine if a negotiated outcome is possible. To accord secured creditors a different standard of deference on a stay application would defeat that legislative objective. The Alberta Court of Queen's Bench in Re Hunters Trailer observed that 'status quo' during the stay period is not merely preservation of pre-stay debt status, but rather preservation of the status quo in the sense of preventing manoeuvres by creditors that would impair the ability of the corporation to operate while it and its creditors determine whether a viable workout is possible.29 In Royal Oak Mines, the court expressed concern about the growing complexity of initial orders being sought under the CCAA stay provisions.30 The court acknowledged the efficiency of bringing pre-packaged draft orders in which the debtor corporation has first sought the input and approval of senior creditors. However, it expressed concern about the growing tendency to attempt to incorporate provisions to meet all eventualities that may arise during CCAA proceedings. Given that stay applications are made on short or no notice, the extensive relief being sought at the initial order stage is beyond what could appropriately be accommodated within the bounds of procedural fairness. The court held that it must balance the need to move quickly with the requirement that parties be given an opportunity to digest the information and advance their interests. The court acknowledged

Judicial Discretion under the CCAA 123 the need for a certain degree of complexity in initial orders, but urged more readily understandable language in such orders, suggesting that 'they should not read like trust indentures/ In applications for extension of the initial thirty-day stay period, the courts apply tests of good faith, due diligence, and prejudice to creditors.31 In addition, the British Columbia Supreme Court recently held that the debtor corporation has an obligation to demonstrate measurable and substantive progress towards a plan if an extension is to be granted, and the court will also consider the economic impact on stakeholders and members of the surrounding community.32 Generally, the court must be satisfied that corporate officers understand the reason for the firm's insolvency and thus whether a potentially viable plan can be devised. The courts also have jurisdiction to lift a stay where they are satisfied that there is prejudice to a particular creditor if the creditor is not allowed to proceed with its claim. They are generally reluctant to do so because the purpose of the stay period is to allow the insolvent corporation reprieve from litigation so that it can direct its resources to negotiating a viable plan with creditors. Recently, in Toronto Stock Exchange Inc. v. United Keno Hill Mines, the Ontario Superior Court of Justice refused to lift a stay to allow the Toronto Stock Exchange (TSX) to pursue proceedings on whether to suspend trading on the corporation's securities.33 The court held that the CCAA, the Toronto Stock Exchange Act, and the Ontario Securities Act were all instruments of public policy. On the evidence, the serious risk to those involved in survival of the firm and the public interest in restructuring outweighed the largely speculative allegation of prejudice to the TSX in the execution of its public interest mandate. The court held that where two streams of public interest are implicated, the interests of affected parties must be weighed. This decision has been criticized as usurping the public policy role of the TSX and inappropriately staying the rights of securities claimants. Yet the court's reasoning in this case does not differ from its long-standing approach to CCAA stays. The courts have consistently refused to lift the stay for human rights enforcement, pay equity claims, employment standards, and labour relations claims during the stay period, on the basis that enforcement rights under remedial legislation must be temporarily suspended in the larger public interest of giving the debtor corporation time to devise a business plan acceptable to creditors. As with securities legislation, these claims involve remedial

124 Creditor Rights and the Public Interest

statutes and public interest considerations. The United Keno case does not depart from this reasoning. What would have been extraordinary is the court lifting the stay where it has consistently refused to do so for arguably more disadvantaged groups. When the public interest does weigh in favour of lifting the CCAA stay, as it did for some tort claims in the Red Cross contaminated blood case, the court has acted accordingly to protect the interests of particularly vulnerable claimants. In recent cases such as PSINet Ltd., the courts have been careful to distinguish between what they properly consider their role and that more appropriately left to the legislative process. The issue in PSINet was whether to lift the CCAA stay to allow re-registration of a formerly perfected security interest under the PPSA34 Prior to the discovery of the lapse during the CCAA proceeding, the parent corporation was considered an unsecured creditor. The court observed that while legislative intervention may be required to close a gap in the statutory language, there was nothing in that language to prevent re-registration, and it exercised its discretion to allow this. The court also observed that this action substantially reduced the realization value for unsecured creditors and ordered both costs of the proceeding and some adjustment to the terms of the CCAA plan to account for the expenditure of time and money by unsecured creditors who had previously had an expectation of greater recovery. In considering applications for leave to appeal the stay order, Canadian appellate courts have held that they will be reluctant to intervene in the CCAA process, especially at an early stage, given that the supervising judge engages in a delicate balancing of interests that an appellate proceeding may upset or frustrate.35 Appellate courts have held that leave to appeal should not be granted where it would prejudice the prospects of restructuring the business for the benefit of stakeholders as a whole, and thus be contrary to the spirit and objectives of the CCAA.36 These judicial pronouncements suggest that the stay mechanism, particularly approval to extend the stay, could be a useful tool for the approach to restructuring suggested in chapter 3. Given that the courts have already recognized that the stay is a protective device that can benefit a broad set of constituencies, it could clearly be used to promote the participation rights of non-traditional stakeholders. For example, the debtor corporation could be obliged to give notice to workers, their unions, and other stakeholders with economic interests in the firm before the initial stay is granted. This is not currently gener-

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ally done. Fuller disclosure could be required at the outset of the process. Use of electronic communication has enhanced the possibility for cost-effective and widely disseminated early disclosure; such disclosure would reduce costs for workers, small trade creditors, ,and other stakeholders seeking to participate. The stay could be granted on condition that the debtor corporation seek the cooperation of these stakeholders in fulfilling its good faith and due diligence obligations in trying to develop a plan. The courts' consideration of motions to extend a stay would take account of these interests, including an assessment of the debtor corporation's good faith negotiations with stakeholders. Moreover, the recent direction to simplify initial orders and to give additional notice and time to allow parties to consider their interests should act to enhance access to the process by those who traditionally have not been involved. Debtor-in-Possession Financing The courts have interpreted their jurisdiction as including the ability to order debtor-in-possession (DIP) financing to allow corporations to continue operating during the stay period under the CCAA.37 This can sometimes represent a compromise of creditors' traditional rights. Prior to the development of DIP financing, debtor corporations required the financial support of operating lenders to carry on business during the restructuring process.38 This ensured accountability on use of funds since, without the support of the operating lender, the debtor corporation did not have the interim financing to cover the period in which it was attempting to develop a plan. It was not until the courts began to grant DIP financing in the absence of unanimous consent of secured creditors, or where there was some interference in priorities, that the courts were faced with questions of the scope and limits of their jurisdiction to grant such financing. The tension between federal insolvency legislation and provincial property legislation, and challenges to the court's jurisdiction, came to the fore in 2000-2. The criticisms focus on whether the courts have jurisdiction to order DIP financing in priority to pre-existing secured claims and whether they have been too slow to acknowledge the prejudice to particular creditors, where income being generated may be required to fund the cost of restructuring. The courts have found authority for granting super-priority financing under both the CCAA and their inherent jurisdiction. Inherent

126 Creditor Rights and the Public Interest

jurisdiction has been defined as a 'residual source of powers, which the court may draw upon as necessary whenever it is just and equitable to do so, in particular, to ensure the observance of the due process of law, to prevent improper vexation or oppression, to do justice between the parties and to secure a fair trial between them/39 Inherent jurisdiction cannot be exercised in a manner that conflicts with a statute, and because it is an extraordinary power, it should be exercised sparingly and only in a clear case.40 DIP financing has been granted in cases where the security was granted on unencumbered assets; where the financing was obtained with the consent of secured creditors; and where the reduction in value of existing creditors' security was not significant in light of the overall value involved and the financial effects of declining such a request.41 In a recent British Columbia case, the court declined to order DIP financing but granted an order funding the debtor's restructuring legal expenses, included as part of the administration charge as a limited substitute. The British Columbia Court of Appeal has held that the effective achievement of the legislation's objectives requires a broad and flexible exercise of jurisdiction to facilitate a restructuring, and the courts' equitable jurisdiction permits orders granting super-priority financing in some circumstances.42 The courts will engage in a balancing of prejudices between the parties, and secured creditors may be required to make some sacrifice because of the reasonably anticipated benefits for all stakeholders including employees, trade suppliers, and other creditors. However, the courts have cautioned that in balancing these interests, there should be cogent evidence that the benefit of DIP financing clearly outweighs the potential prejudice to the lenders whose security is being subordinated or unsecured creditors where it may eliminate the possibility of any recovery.43 In GE Capital v. Euro United Corporation the court declined to approve DIP financing because secured creditors were able to establish a serious lack of confidence in governance of the corporation and very high risk of prejudice to creditors.44 The courts have held that DIP financing requests in initial orders should be confined to what is reasonably necessary for the continued operation of the debtor corporation during a brief but realistic period on an urgent basis. In Royal Oak, the debtor was seeking super-priority financing over all lenders, including some lien claimants.45 The lien claimants, who ranked first in priority, were not given notice of the application. The court was concerned about the quantity and broad

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terms of the proposed DIP financing, given that interested parties had not had the opportunity to properly review the information and consider their position in terms of whether a CCAA, receivership, or bankruptcy proceeding was more appropriate. The court held that granting such priority can place encumbrances ahead of pre-existing claims and such changes should not be imported lightly, if at all, into the creditor mix. It limited the amount of DIP financing sanctioned in the initial order. In the same CCAA application, the court subsequently held that its jurisdiction was not limitless, and statutory liens such as the Builders Lien Act operated to limit the courts' jurisdiction to grant super-priority financing over the lien claimants. Zimmerman has argued that it is fundamentally unfair that those with little economic incentive to allow the debtor corporation to restructure should be asked to bear both the risk and cost of superpriority financing that subordinates their position.46 He argues that the law should facilitate the efficient operation of free financial markets, and that where there is economic incentive to fund, the debtor will be able to find financing. He suggests that courts could make early determinations of class, and then have the classes vote on the same basis as required for endorsement of a proposed plan of arrangement. Only where the class has consented, or the court deems it to have consented, will super-priority in DIP financing be given over that particular class. The difficulty with this approach is that it assumes no information asymmetries and relatively high sophistication among the parties early in the process. Yet the senior secured creditors already have the greatest access to the court-supervised process as well as the information and resources to effectively argue that the court should not exercise its equitable jurisdiction in a particular case. The proposal does not adequately address the interests of employees, local trade suppliers, contingent creditors, and others who require time to clarify their interests and to seek status, counsel, and information in order to effectively participate. Premature definition of class in the proceeding could further disadvantage these parties by foreclosing their ability to make submissions on a key restructuring issue. Moreover, the courts' precise reason for exercising their inherent jurisdiction is that the objectives of the CCAA are broader than the preservation of creditors' claims. While few would disagree that some legislative guidance on this issue would be helpful, it is unclear what early voting in respect of DIP financing would constructively contribute to this process, apart from

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giving secured creditors a veto over super-priority financing and thus in all probability a veto over the ability of the debtor corporation to continue operating as a going concern during the negotiations for a workout. The British Columbia Court of Appeal rejected Zimmerman's approach in United Used Auto.47 The court confirmed its equitable jurisdiction to order super-priority financing in order to facilitate negotiations, finding that the objective of the CCAA extends beyond protecting assets for eventual realization by creditors. At the same time, the court cautioned that granting DIP financing on a priority basis can erode the security of creditors and thus the courts should make such orders only where there is a reasonable prospect of successfully restructuring. The Alberta court recently endorsed this reasoning in Re Hunters Trailer where the court refused to increase the amount of DIP financing because the debtor corporation failed to lead evidence that the benefits of further financing outweighed potential prejudice to creditors.48 The granting of DIP financing may allow a corporation to keep operating. For stakeholders such as workers or local governments, it may also result in preservation of their equitable investments, at least for the period during which a restructuring plan is being formulated. According super-priority financing has also been aimed at protecting or ensuring compliance with environmental obligations, an aim clearly in the interests of the public.49 Approval of DIP financing to keep 'the lights on' may also assist local suppliers in terms of their investments in the firm. Since they can demand cash in exchange for any new supplies, DIP financing might ultimately be aimed at preserving their interests. Conceivably, the courts could use this discretionary power as another tool in according stakeholders a role in the process. For example, where a corporation has failed to give adequate notice of the DIP financing request or to disclose its finances to trade or other creditors, the courts could refuse to grant further financing or they could make further financing conditional on increased disclosure to these multiple interested parties. In the 2001 CCAA application of Algoma Steel Corporation, the court granted a $50 million DIP financing order without notice provided to the first secured creditors.50 This DIP financing order has been criticized as an abuse of the CCAA process because of the ex parte nature of the motion and because the operating lender providing the DIP financing secured it as a first charge in priority without allowing the

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noteholders the opportunity to make submissions to the court. The lack of notice is clearly problematic. Given that these were sophisticated parties, notice, even on an urgent basis, should have been given prior to subordinating secured interests. In this respect, the order was inconsistent with the courts' growing practice of declining to deal with such motions on an ex parte basis. In making the order on an ex parte basis in Algoma Steel the court was persuaded by the urgency of the request in the particular instance. The court's endorsement particularly emphasized that creditors who had not received notice should use the comeback clause. In balancing the interests involved, the court also attempted to limit the priming effect on the noteholders' security by restricting draws on the DIP facility to $20 million in the first thirty days. Further restrictions were subsequently imposed.51 When the first mortgage noteholders sought leave to appeal the decision, the Ontario Court of Appeal held that the granting of the DIP financing was made on an urgent and interim basis: a serious negative cash-flow crisis, meant that, without short-term assistance, Algoma was at risk of ceasing operations.52 It held that the motion for leave to appeal was premature, that the CCAA expressly authorized orders on an ex parte basis, that the lower court had invited dissatisfied parties to bring motions on a timely basis, and that the appellate court would not lightly intervene in the early stage of a CCAA proceeding. This curial deference to DIP financing orders enhances the ability of the supervising judge to take account of diverse interests in rendering decisions that meet the statutory objectives of the CCAA. There is an increasing issue of how costs are to be allocated in terms of DIP financing. The costs have frequently been borne by the lowest secured creditor whose interests may be submerged once the DIP or other charges are paid. More recently, the courts have exercised their inherent jurisdiction to allocate costs among creditors. The Alberta Court of Queen's Bench in Re Hunters Trailer held that in allocating the costs and expenses of the CCAA proceeding, including the DIP financing and administrative charge, the courts have a duty not to readjust the priorities between the creditors; however, in meeting the objectives of the CCAA to facilitate an arrangement where possible, the court should allocate costs on an equitable basis.53 The notion that financing is a potential benefit to all creditors is critical to the equitable allocation of costs. However, just as it is important to ensure that the exercise of discretion on DIP financing does not give the senior secured lender a 'veto' over the process, the same is relevant to cost

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allocation. Further judgments will determine whether or not there is a risk that disputes about the jurisdiction to order DIP financing will shift to allocation disputes, with some creditors seeking allocations that defeat the interests of more vulnerable claimants, thus increasing the risk of creating a de facto veto over the process through this means. Although a number of practitioners refer to the bundle of types of priority financing and charges as DIP financing, a distinction can be made between financing that allows the debtor corporation to continue operating (DIP financing) during the period of workout negotiations and a variety of other court-ordered charges that are given priority (priming liens) in order to cover the expenses of the restructuring proceedings or to protect particular vulnerable creditors. The court's determination in all these instances is based on its exercise of equitable and inherent jurisdiction. Financing orders have been approved by the courts to cover administrative charges in a CCAA proceeding; to protect directors and officers from liability exposure; for specific environmental maintenance programs; to cover expenses and fees of a representative creditor and its legal counsel; and for post-petition trade creditor charges.54 Review of the courts' decisions indicates that the threshold for granting financing for monitor's fees and other administrative charges has been lower than that of DIP financing for continued operations.55 This is because the courts have consistently recognized that the monitor is acting to protect the interests of all creditors. Although trade creditors are not required to continue extending credit, they often do, largely as a function of information asymmetries and a belief that the fact that there is a court-supervised process somehow protects their interests, when in reality there is no priority for this continued extension of trade credit, absent an express order by the court. Post-petition trade creditor (PPTC) charges have now become a different type of DIP financing, in the sense of freeing up resources to pay trade creditors, to ensure that the business can keep operating during the workout period.56 This development of PPTC is increasingly being used, particularly in Alberta. It does not yet appear to be a financing strategy utilized to any extent in Ontario; generally, the view has been that suppliers should require cash on delivery payments for goods received post filing or in some cases, guarantees from the insolvency officer. However, post-filing creditors frequently have been harmed because they continue to advance credit, even though they are not required to, and then are not able to enforce their claims. The increased use in PPTC charges is aimed at redressing the situation

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where small trade creditors continue to supply on credit 'at their own risk/ where they do not fully appreciate their vulnerability. In Re Smoky River Coal Ltd., the Alberta Court of Appeal held that it is particularly important that the terms and scope of any charge created by an order be clearly defined, that creditors need to know at the outset whether or not they are entitled to the benefit of a PPTC charge and secured lenders are entitled to know the extent to which a PPTC charge will affect their security.57 While the growing practice of granting PPTC charge is a helpful development in fostering the continuing supply of goods and services during the workout period, the court's observation about certainty for the parties is extremely important. If such creditors have to bear the costs of litigating whether or not they are covered by the charge after the fact, the costs of litigation will act as a barrier to enforcement of their claims. A priority charge is also occasionally granted to representative counsel. In the most recent Dylex proceeding, the court appointed a former employee and his representative counsel to represent the interests of employees in both the CCAA and BIA proceedings, with the counsel's fees to be paid on a priority basis as part of the cost of administration.58 As discussed in chapter 3, this type of order allows for enhanced participation rights and can ultimately reduce the costs of the proceeding by providing a cost-effective way of ensuring that employees' interests are represented in the plan negotiations. The courts apply a cost-benefit analysis to the granting of priority charges. Recently, the Ontario Superior Court of Justice rejected an application for a shareholders' oversight committee to participate in the CCAA proceedings, including negotiation for a plan and mediation efforts with a senior creditor.59 The court held that there was no reasonable prospect for shareholders to salvage any equity and therefore there was no economic interest to protect. It would have been inappropriate to appoint a shareholder oversight committee with a first charge on the assets, as the costs would be inappropriately borne by creditors who already faced a severe discounting of their claims. The federal government is currently considering whether to codify provisions for DIP financing in the CCAA in its 2002-3 parliamentary review of the legislation. Interestingly, in its cross-Canada consultations, the jurisdiction of the courts to grant the financing has generally been accepted. The issue has been the scope of any guidelines that should be enacted. These guidelines might include notice requirements for priority charges and express authority to apportion costs across

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multiple parties to the restructuring. Such recommendations are aimed at ensuring sufficient information to allow the court and the parties to determine the benefits and prejudice of such financing, as well as recognizing that the financing is for the benefit of all creditors and thus that the costs should be shared more appropriately. However, some secured creditor interests have lobbied for the imposition of much more stringent restrictions on the exercise of judicial discretion, and for allowing senior creditors a veto in the process. The impact of these well-funded lobbying interests remains to be seen. Definition of Classes as a Tool to Facilitate Restructuring The approval of a proposed plan of arrangement or compromise is dependent on the creditors voting in favour of the proposed plan by class in terms of a majority of creditors and two-thirds of the value of the claims. Thus, the determination of 'class' becomes a key issue in CCAA proceedings. Creditors placed in classes in which the other creditors are very supportive of the debtor corporation have much less chance of vetoing a proposed plan. As a consequence, both creditors and the debtor corporation typically attempt to frame the classes in such a way as to maximize their voice and control rights in the restructuring process. There has been considerable litigation on the issue of what comprises a class of creditors for purposes of the CCAA. The courts apply a 'commonality of interest' test. If a court finds that a different state of facts exists among creditors, which may affect their minds and judgment differently, they must be divided into different classes. A class should be made up of creditors whose rights are 'not so dissimilar as to make it impossible for them to consult together with a view to their common interest/60 In Canadian Airlines, the Alberta Court of Queen's Bench held that classes should be determined having regard for legal interests, and that commonalty of interest is to be viewed purposively, bearing in mind the objective of the CCAA to facilitate restructuring plans.61 Creditors often seek to be placed in separate classes based on the type of security or its legal or commercial attributes, so that they can exercise effective veto and have enhanced bargaining power in the workout. The courts have sometimes adopted an anti-fragmentation approach, grouping creditors with a sufficient community of interest and rights so as to not unnecessarily fragment the voting process and thus allow one creditor to unduly influence negotiations or to defeat the proposed plan.62

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The debtor corporation's employees are often included in a single class with other unsecured creditors in the plan. In Re Woodward's Ltd. the British Columbia Supreme Court refused to classify terminated employees as a separate class, instead including them with other unsecured creditors who were more supportive of the plan.63 The definition of class can thus be used as a form of 'cram down' of the plan on dissenting creditors within a class. Although Canada does not have formal cram-down provisions such as those contained in the U.S. Bankruptcy Code, the fact that classes can be creatively constructed, and that their designation requires court approval, results in a situation where the courts can and have used the definition of classes of creditors to facilitate acceptance of a plan. There is some controversy about the courts' role in this type of 'cram down' through approval of classes, particularly since the debtor usually proposes the class definitions. The courts will generally accept definitions of class that meet the CCAA's objective of creating a mechanism to facilitate restructuring, while respecting, as much as possible, the rights of creditors. The same rationale might be used to persuade the courts to define classes in a manner that enhances the participation and decision rights of broader numbers of stakeholders. The courts would have to be persuaded that the addition of classes, or the classifying of workers and other stakeholders separately from other unsecured creditors, is with a view to advancing the objectives of the legislation. Given both the anti-fragmentation and commonality of interest approach of the courts, workers or other investors would have to persuade the court that the nature of their interest or investment was such that their 'minds and judgment are differently affected' and it is impossible for them to 'consult together with a view to their common interest.' Since the rationale for enhanced participation and decision rights for such stakeholders is that they have unique human capital investments or a higher value interest in the successful restructuring of the corporation, such arguments might be persuasive. The courts will also consider the timing of objections to definition of class. In Armbro Enterprises, when a landlord sought separate class status, the court held that there was sufficient community of interest between the landlord and other unsecured creditors, and that a separate class would cause unnecessary fragmentation.64 The court also found that the landlord had adequate notice and had failed to raise the matter early in the process. To wait until the sanctioning hearing was too late unless there was some sort of substantial injustice, which it found did not exist in this instance. Thus, where stakeholders are

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seeking decision rights through the definition of class, they will have to establish those interests early in the process. How claims are satisfied within a class may also encourage recognition of human capital or other investments. In the CCAA application of Mac's Milk, there were 596 directly employed workers, 748 independent dealers, and 284 franchise stores employing 16,000 workers.65 Although workers were in the same class as unsecured creditors, their claims were treated differently in order to give them a choice regarding the amount of risk they were willing to bear in the restructured corporation. The evaluation of workers' claims was based on a formula that took into account job levels and experience. Workers were then given the option of receiving shares in the amount of their claims and acquiring the attendant risk or of taking 50 per cent of the value of their claims in cash payments over eight quarterly payments. The Sanctioning of the Plan of Arrangement or Compromise The CCAA contemplates that the courts will approve a plan of compromise or arrangement. In a prior step, the courts approve a process for creditors to vote on the proposed plan. The Alberta Court of Appeal in Fracmaster held that in exercising its discretion to order a vote, the court must consider whether the proposed plan of arrangement has a reasonable chance of success.66 Once the vote is held, if the proposed plan receives the requisite creditor support, the court holds a sanctioning hearing. In considering whether to sanction a plan, the court will examine three criteria: whether there has been strict compliance with all the statutory requirements; whether all materials filed and procedures carried out were authorized by the CCAA; and whether the plan is fair and reasonable.67 In terms of the statutory requirements, the debtor corporation must prove that it is insolvent within the meaning of the legislation. The court will also assess the appropriateness of the classes, whether the meetings were held and votes conducted in compliance with the statutory scheme, and whether the plan was approved by the requisite double majority.68 In assessing the fairness and reasonableness of a plan, the court has held that '"fairness" is the quintessential expression of the court's equitable jurisdiction - although the jurisdiction is statutory, the broad discretionary powers given to the judiciary by the legislation makes its exercise an exercise in equity - and "reasonableness" is what lends objectivity to the process.'69 Fairness is assessed by determination of

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whether the plan is feasible, whether it fairly balances the interests of the creditors, the company, and its shareholders. The courts have held that they must weigh the equities or balance the relative degrees of prejudice that might flow from granting or refusing the relief sought under the CCAA.70 One measure of whether a plan is fair and reasonable is the parties' degree of approval of the plan. It has been held that parties generally know what is in their best interests, and in engaging in the fairness inquiry, the courts will be reluctant to refuse to sanction a plan where creditors have strongly supported it.71 In the absence of express statutory language requiring that every class must approve the plan, the courts have held that approval of a plan by all classes of creditors is not always necessary where the plan is found to be fair and reasonable.72 In Olympia & York Developments, a plan involving twenty-nine affiliated corporations proposed a fiveyear strategy akin to a controlled liquidation, with a series of complex restructuring transactions. Secured creditors were to receive interest payments and were able to opt out of the plan and, on notice, to realize on their security at any time.73 The claims of unsecured creditors, likely of no value on liquidation, were postponed for five years, with interest to accrue at the rate specified in the particular contract. Unsecured creditors were given ongoing rights of disclosure, some control over transfer of real estate, and at the end of the five years, the option of converting their debt to stock. Only twenty-seven of thirtyfive classes of creditors voted in favour of the plan, and the plan specified that the claims of creditors who rejected the plan were not bound by its provisions. The court held that it would not sanction a plan if the effect would be to bind a class of creditors that had rejected it. Here, there was no prejudice to the classes of creditors who did not approve the plan, as none of their rights had been taken away. Thus, sanctioning is not dependent on unanimity of approval among classes. Once the court sanctions a plan, it becomes binding on the debtor company and on its creditors. Thus, fairness and reasonableness are assessed in the context of a proposed plan's impact on creditors, having regard to the purpose of the statutory scheme. Courts will look at all categories of interest holders in assessing if compromises are fair and reasonable in the circumstances.74 Where a plan has been accepted by creditors, the party seeking to have the court reject the proposed plan must establish that the plan is unethical or that there are serious grounds for refusing to sanction it.75 Only in exceptional circumstances will the plan be amended once it has received court approval.76

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One critique in respect of sanctioning a plan is that parties may succumb to 'deal fatigue' such that they agree to a plan because they are tired of negotiating and do not want to see the value of their credit further diminished. While deal fatigue exists, secured creditors as key creditors are not powerless during the process. After the initial stay, they can seek to end the process where the debtor is not proceeding expeditiously. They can and do use their bargaining power both for leverage within the negotiation process and before the court, and they negotiate particular control rights during the process. Deal fatigue, while it can be a major factor in a dispute resolution process, in this case fails to account for all the interim check points where creditors have considerable voice in either moving the process along or persuading the court to end it. Although less criticism has been directed at the courts' exercise of jurisdiction in sanctioning plans, one issue is how well placed the courts are to assess the feasibility of a plan. The courts have held that their function is not to examine the details of a business plan in all its minutiae, nor will they second guess or substitute their own judgment for the business judgments of creditors involved in negotiating a plan in their own best interests.77 Rather, the court's role is to satisfy itself that the plan is feasible and that it fairly balances the interests of the company, its creditors, and its shareholders. Part of that assessment involves examining the sophistication of the creditors and whether they received experienced legal advice. At the point of the sanctioning hearing, the creditors have already expressed their support for the plan in the requisite statutory amounts and thus are representing to the court that in their business judgment the plan should be approved. However, where parties disagree as to what that business judgment is, or believe that the process to work out content of the proposed plan has been unreasonable or unfair, the court will consider the evidence and submissions of the parties and engage in a balancing of prejudices. Mr Justice Forsyth of the Alberta Court has observed that the true test of judicial discretion is whether it is exercised to ensure a level playing field for discussion, allowing all constituents an equal opportunity to put forward their position while recognizing at all times that ultimately, the success or failure should be based on a business judgment, rather than a judicial decision under the guise of judicial discretion.78 A plan that preserves the business under new ownership may also meet the objectives of the CCAA.79 In the concurrent CanadaU.S. court approval of PSINet asset sale, the court held that the sale

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generated the highest enterprise value, was in the best interests of creditors, preserved two hundred jobs, and prevented service disruption to corporate accounts.80 In another cross-border proceeding, the court certified a class action relating to allegations of misrepresentation in a public offering. However, it declined to approve the settlement of both U.S. and Canadian class actions as premature within the CCAA process. To do so would have given one group of unsecured claimants an unwarranted advantage over another, impaired the ability of some claimants to engage in full and complete negotiations, and prematurely placed the restructuring at risk.81 Thus the court adjourned the question of approval of the settlement to a date contemporaneous with the sanctioning hearing, with notice to be sent to all members of the class. The CCAA plan sanction process has also been criticized for failing to consider whether a plan should be sanctioned where it does not account for those that have disproportionately contributed to the restructuring exercise. This critique refers to capital contributions, as opposed to any other interests of 'high value' creditors. Yet the sanctioning stage, where the court has before it a plan that has already garnered the requisite creditor support, is not necessarily the stage at which such issues should be considered. Creditors have an ongoing opportunity to bring issues before the court regarding fairness in treatment, and the courts will intervene where the prejudice outweighs the potential benefits of the process. The courts' approach to the fairness and reasonableness inquiry is clearly creditor based. This makes sense, given the statutory language. However, the courts have been equally clear that the assessment of fairness involves a balancing of the equities in any given case. Thus, the fairness hearing could facilitate consideration of broad stakeholder interests. Where stakeholders are creditors within the meaning of the CCAA, the courts will already balance the relative equities and prejudice. If courts could be persuaded to recognize the broader investments at risk, these interests could be included in the balancing of equities at the hearing to approve the plan. This acknowledgment would enhance participation and decision rights, because debtor corporations and traditional creditors would understand that the court will ultimately take account of these interests. In Canadian Airlines, the Alberta Court of Queen's Bench held that the court's role in the sanctioning hearing is to consider whether the plan fairly balances the interests of all stakeholders, that its role is to

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look forward and determine whether the plan represents a fair and reasonable compromise that will permit a viable commercial entity to emerge.82 The courts have also suggested that the debtor and its advisers need to have a clear understanding of the source of the debtor's financial distress if there is to be a viable workout. A temporary downturn in the market may in some cases have precipitated financial distress. In other cases, the problem may be managerial slack, a debt/ equity ratio that cannot be sustained, or management's failure to respond adequately to capital market changes. Debt provides a valuable discipline on corporate decision making both before insolvency and during the workout.83 In reviewing CCAA sanctioning orders, the appellate courts have held that leave will be granted sparingly, that the court must be satisfied that there are serious and arguable grounds of real and significant interest to the parties.84 In Country Style Food Services, where retail franchisees became aware of differential treatment after a plan was approved, the court declined to grant leave because the information was disclosed on the website and in proxy circulars to creditors. While the franchisees were not on the notice list, the monitor had sent notice of the website to the franchisees and they could have discovered this information with due diligence. The court also observed that, where a franchisor seeks CCAA protection, even though the statute contemplates notice only to creditors, it may be appropriate to give franchisees notice and the opportunity to request participation rights.85 This reasoning supports more fulsome notice and disclosure to parties that may have an interest in the workout process. Parties are entitled to some certainty with respect to how the courts will view the value or quantum of claims, to enable them to negotiate credit arrangements. This is critically important and links back to the principles suggested in chapter 3 for calculation of the value of stakeholder claims. The courts' determination of the value of claims would be facilitated by actuarial calculations assigning a value to amounts invested by local governments in infrastructure to support a corporation or according a value to prior human capital investments. Although judicial decision making would clarify which types of calculations appropriately value claims, the mechanisms are already in place for such valuations. A clear understanding of the quantum of claims will facilitate workouts. It will also help lenders ex ante assess the ex post risks involved in granting credit so that they can determine whether or not to provide the financing.

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This is not to suggest that quantifying and valuing stakeholder investments will always be easy. In the absence of specific information, the courts are unlikely to fully value these interests. For example, in Re Repap British Columbia Inc., the debtor corporation was to be restructured under an arrangement in which workers at the pulp mill would receive 20 per cent of the equity in the restructured corporation.86 An issue arose as to how the equity was to be allocated among the workers. The corporation and managerial employees successfully argued that it should be divided by wage amount, in recognition of wage concessions made. This substantially favoured corporate managers. Two unions argued that allocation should be made on a per capita basis, in recognition not only of the wage concessions but also of contractual concessions on trade flexibility and contracting out. On the face of the judgment, the court does not, however, appear to have had any valuation of these other concessions before it. The court found that it was not in a position to analyse details such as a trust arrangement and income tax considerations, and thus it made the distribution decision based on fixed capital wage claims. The British Columbia Court of Appeal refused to grant leave to appeal on the basis that the allocation was unique to the circumstances, that the decision of the chambers judge should not be lightly interfered with, and that there was no substantial injustice created by the decision. The judgment indicates that, absent some means of assigning a value to the interests of workers, in this case contractual benefits that had previously been bargained for and which were compromised under the CCAA, the courts are unlikely to look beyond the fixed capital claims in determining or valuing interest. Finally, the 'free-market enterprise' critique suggests that the courts should not intervene where the market corrects the failure of a firm and determines whether liquidation or sale is the most efficient use of assets.87 While one can agree that the assets should be put to their highest use and that preserving inefficient management in a workout will not assist in generating long-term value, the notion that the market will correct everything is somewhat naive. Corporate law is not currently a function of free markets; it is highly regulated by corporation and competition statutes, securities law, and a system of credit registration and enforcement. To suggest that creditors and firms should receive the benefits of highly regulated regimes when the corporation is doing well, but that there should be no public policy checks and balances on firm financial distress, is to argue that the free markets

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should only operate where it is in the interests of one group implicated in the insolvency. The CCAA was designed to allow a period in which more diverse interests are accounted for, preserving bankruptcy as the ultimate safeguard for creditors and a hierarchy of claims enforcement if parties cannot agree to a workout strategy in a timely manner. Ontario's Case-Managed System: Effective Judicial Oversight of Restructuring Co-operation, communication and common sense are the three commercial court canons driving Ontario's case-managed process. Mr Justice Farley, Ontario Superior Court of Justice, 2001

An effective restructuring system is premised on access to the court during the process. While restructuring should focus on commercial viability, the ability of parties to seek direction or to have disputes resolved expeditiously ensures that the process of negotiation continues on a timely basis. In Canada, insolvency legislation is administered by the superior courts in each province, and the Ontario Superior Court of Justice, Commercial List, is a prototype for effective judicial oversight of restructuring proceedings. The expertise of the court and the efficacy of its case-managed system have proven effective in complex restructuring cases and the majority of CCAA applications are brought to the Commercial List. The model was adopted to an extent by Quebec's Superior Court in late 2001. The Ontario case-managed system is unique in two respects.88 First, there is the existence of the Commercial List. The second distinction is the hands-on nature of the court itself in CCAA matters. The key elements of the case-management system include facilitating negotiation, liberal access to the case-managing judge, and the issuing of interim orders to keep the process both expeditious and accountable. By way of comparison, British Columbia has no specialized bench, although several judges with considerable insolvency and corporate expertise are routinely assigned to CCAA cases. The assigned judge hears all motions relating to that case or related cases. Although the judges with expertise have a strong record of fair and timely decisions, one practitioner has suggested that the lack of a commercial roster means that the success of a restructuring in British Columbia is in part 'luck of the draw/89 In Alberta, several judges with commercial expertise

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have been instrumental in assisting parties in the CCAA proceeding, but again there is no specialized division of the court assigned to such matters. Similarly, Quebec, prior to 2001, had no specialized bench. Several judges with corporate/commercial expertise were assigned to CCAA cases. In Atlantic Canada, there have been problems with a lack of informational capital in terms of both the parties and the courts.90 The principal merit of the Ontario Commercial List case-managed system is that it allows matters to be dealt with fairly, expeditiously, and efficiently. Proceedings under the CCAA are more expeditious than those under U.S. Chapter 11 proceedings; matters are often completed in a few months instead of two to seven years.91 Many issues arising under CCAA applications are in fact dealt with in hours or days. The Commercial List hears cases in considerably less time than the court's regular trial list, because parties adhere to the fairly rigorous requirements of its practice direction.92 The operating premise is that parties will have considerable input in establishing the process and time frame of a restructuring application, but once the process is in place, the court will expect them to adhere to the schedule set. Expeditious decision making at the point of insolvency is required to prevent the further depletion of value for creditors, and the court's practice directions assist parties with timely resolution of disputes. A Commercial List Users Committee advises the court on how to improve its accessibility and efficiency.93 In CCAA cases, the court requires full and early disclosure of the financial situation of the corporation so that stakeholders are able to make timely and informed decisions about their support for a possible restructuring. The court has also created very liberal access to '9:30 appointments.' These are ten-minute meetings with the case-managing judge in chambers to resolve matters of scheduling, minor disputes on disclosure, consent matters, and simple directions. The court may endorse an order or give informal but clear directions to the parties to ensure the process keeps moving forward. Often 9:30 appointments are scheduled on the same day as requested or on a 'walkin basis,' obviating the need to bring formal motions and thus controlling transaction costs. Although the supervising judge will deal with ex parte motions on an urgent basis, the court will not decide matters where adequate notice has not been given to interested parties, or where the matter should be properly decided in a public hearing. The informality of the court, combined with serious regard for the rules of natural justice, creates a forum where workers, local governments,

142 Creditor Rights and the Public Interest and other new parties to restructuring proceedings can be assured of a reasonable opportunity to be heard, as the discussion of Red Cross and Anvil Range in chapters 6 and 7 will illustrate. Case-reporting conferences are frequently held in open court, and the court can be quite vigorous in questioning parties' progress in the negotiation for a workout. In Loewen, the court asked a number of pointed questions regarding the efforts of the debtor corporation to develop a viable business plan and coordinate the Ontario proceedings with U.S. Chapter 11 Bankruptcy Code proceedings, notwithstanding the fact that all the creditors at the hearing fully supported the debtor corporation's efforts. The court noted the need for flexibility on the part of both U.S. and Canadian courts but reminded the parties that the interests of multiple creditors and minority interest holders in 800 Loewen related companies, as well as more than 13,000 employees, were affected by the corporation's decisions at each stage of the proceedings.94 The court extracted a number of commitments from the debtor corporation to expedite resolution of the issues in both jurisdictions, aimed at facilitating the participation of multiple stakeholders while trying to contain costs. The Commercial List process is particularly suited to complex cases. Early disclosure and negotiation may enhance the ability of workers and other equitable investors to participate because it ultimately reduces costly court appearances. The recent direction by the court for better notice and plainer language can only assist workers, small trade suppliers, and other stakeholders seeking participation rights. Adequate notice is particularly important. Given that workers' claims are viewed as fixed, often the debtor corporation does not give workers or their union notice of CCAA proceedings. For example, in each of the cases of Anvil Range, Red Cross, and Royal Oak Mines Inc., the workers and their unions were not given notice of the proceedings until some discreet issue of pension liability, other fixed claims, or stays on grievance arbitration proceedings arose.95 Often at this stage, important decisions have already been made, including the court's sanction of detailed initial orders that stay the rights of employees and limit the liability of court-appointed officers in terms of employment and labour law. While workers can take advantage of the 'come-back' clause, in reality, most workers do not have the sophistication to appreciate the remedies available to them. As the court observed in Royal Oak Mines Inc., the come-back clauses in initial orders do not provide an answer to overreaching initial orders, because while there is no formal onus on a party applying to vary the initial order, the momentum estab-

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lished in the process creates an inherent disadvantage to the party seeking to alter its provisions.96 Early notice and disclosure to stakeholders can facilitate the early identification of their interests and allow them to seek to enforce what participation and decision rights that they can establish. Dispute resolution is multifaceted and direct negotiations between parties with an interest in the insolvent corporation are a crucial part of CCAA proceedings. Dispute resolution can be effective in redressing power imbalances in a CCAA workout. The court will facilitate negotiations to ensure that they take place on a principled basis, although it has said that generally, alternative dispute resolution should only be attempted where the parties agree that a viable enterprise can be salvaged. Formal mediation has only been used on consent of the parties concerned, with the exception of the 1992 Algoma Steel case, discussed in chapter 5. The parties had already agreed that the business plan was viable, and the court, noting that 'there would be no reason for the city to exist without the company/ ordered mandatory mediation to facilitate the outstanding financing issues.97 While the banks initially argued that the court did not have the jurisdiction to issue the mediation order, they agreed to participate when the process appeared to be workable. It is doubtful at any rate that the banks would have been successful in challenging the court's jurisdiction in this respect. The court has inherent jurisdiction to order procedures that create access to justice, including disclosure, claims resolution processes, and confidentiality regimes.98 Ontario now has a scheme of mandatory mediation in civil cases, the genesis of which was successful mediation in the Algoma Steel case. The court's willingness to balance the complex interests of multiple stakeholders may support the ability of non-traditional creditors to participate in such proceedings without unduly adding cost or delay to the process. The court is aware of barriers to participation posed by costs, and its willingness to facilitate expeditious resolution of disputes can assist stakeholders at risk of loss of their equitable investments. Legislation is only effective when access to the process and to fair and expeditious resolution of disputes is available. Court-Appointed Officers and the Governance of Insolvent Corporations The courts accord considerable deference to the recommendations of various court-appointed officers in insolvency proceedings. The views

144 Creditor Rights and the Public Interest

of these officers with respect to the requirements of the public interest and the proper balancing of interests of stakeholders thus has an impact on governance of the corporation during CCAA proceedings. Numerous court-appointed officers are involved in insolvency proceedings, including the monitor under the CCAA. The court had previously exercised its inherent jurisdiction to appoint monitors in CCAA proceedings, and in 1997, the legislation was amended to make the appointment of monitors mandatory." The court also appoints a receiver following an unsuccessful CCAA application. The receiver has an obligation to consider the interests of creditors, and may also have a role to play in facilitating some sort of workout in terms of an asset sale in order to preserve some value in the firm while maximizing value for creditors. Moreover, the receiver must ensure that someone is operating the business in the period after a failed CCAA application and pending a decision about the future of the corporation. The Monitor As set out in the CCAA, the monitor shall monitor the company's business and affairs; have access to and examine the company's property; file reports with the court on both a periodic and specified basis on the state of the company's financial affairs; report on any material adverse change in its projected cash flow or financial circumstances; and advise creditors of reports filed with the court. The provisions also specify the circumstances in which the monitor is not liable and directs debtor corporations to provide the assistance necessary for the monitor to carry out its functions. The legislative amendments codified the court's existing practice. The court can also exercise its discretion to direct the monitor to perform certain functions as it considers appropriate in the circumstances. The court will assess recommendations of its court-appointed officer based on the role assigned and the principles to be applied in the circumstances. For example, in Skydome Corporation, an insolvency involving Toronto's baseball and football sports complex, the monitor was directed to coordinate the sale process: to ask for expressions of interest in an auction, arrange for confidentiality agreements in the bid process, set up an advisory committee of stakeholders, assess the offers, and bring a recommendation to the court.100 These functions were undertaken in the context of CCAA proceedings, but they were akin to those of a receiver in a disposal of assets. In approving the

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monitor's recommendations the court applied the tests used in that analogous situation, specifically, whether the monitor had made a sufficient effort to obtain the best price and had not acted improvidently; whether it had considered the interests of all parties affected; the integrity and efficiency of the process by which offers were obtained; and whether there had been any unfairness in the workout process. In Skydome, the court accepted the recommendation of the monitor and approved the offer as fair and reasonable. The role of the monitor and other court-appointed officers under the CCAA raises some important governance questions. How the officer undertakes the balancing of interests is crucially important, given the high level of deference paid by the court to its recommendations. Where the monitor understands its role to be one of ensuring that all interests are considered, the process tends to be more successful, transaction costs are lower, and there is greater buy-in by all parties, whatever the final outcome of the proceeding. However, where such officers privilege the interests of secured creditors or accord little value to the interests of unsecured creditors or other stakeholders, they may not have adequately performed their role. Similarly, where the monitor has also been the auditor of the debtor corporation, questions may arise about its ability to act in the best interests of the general body of creditors. The outcome of the proceedings, whether a restructuring or a sale, can suffer from a potential conflict of interest. Value may not have been maximized, or transaction costs may have increased from litigation by those parties that believe their interests were not considered. Thus, the governance role of monitors needs further guidance from the court. Current practice under CCAA applications has been uneven. In some cases, the officer has been instrumental in ensuring that the interests of equity, debt, and equitable investors have been carefully considered. In other cases, such as Med-Chem, discussed later in this chapter, it is unclear that the officer fully appreciated the importance of such a governance role. In T. Eaton Co., the court reminded the monitor of the necessity of remaining neutral and objective in the CCAA proceedings.101 Geoff Morawetz suggests that the monitor must consider the voices of smaller interests to whom it owes an obligation; otherwise, they are unlikely to be heard.102 While the court should be able to defer to the expertise and business judgment of its officers, in its supervisory capacity the court must ensure that the officer is fulfilling its governance role. Without such judicial oversight, the ability of diverse stakehold-

146 Creditor Rights and the Public Interesresttt

ers to participate meaningfully will depend on the particular officer appointed. As the role of the monitor evolves, questions of its accountability to the courts and to stakeholders will likely arise. Recently, in Re Laidlaw, the court held that the monitor as a court-appointed officer must 'objectively look out for' and be concerned with protection of the reasonable interests of all stakeholders, including the shareholders.103 However, where shareholders have no reasonable expectation of a future equity interest, there is no economic interest to protect. In the Canadian Airlines proceeding, the noteholders sought to crossexamine the monitor on its liquidation analysis, the first time that such an issue had come before the court.104 Madame Justice Paperny (then) of the Alberta Court of Queen's Bench concluded that crossexamination might not be necessary if the monitor provided further information. It directed the noteholders and dissenting shareholders to send written questions to the monitor, finding that if the need arose, the court would put questions to the monitor in the courtroom. The monitor subsequently answered almost seventy questions in two Special Reports and the issue became moot. The court's approach reflected the public interest in full disclosure of the monitor's reasoning while protecting the monitor as an officer of the court. It is also important to note the role of insolvency counsel in restructuring cases. Counsel are officers of the court, although they represent the interests of their clients. Jones and Dixon, in discussing the Oakwood Petroleum case, point out that it was essential, in giving advice, for counsel to consider the interests of a number of constituencies, including workers, directors, shareholders, creditors, governments, and the general public.105 The dynamics of the CCAA process are such that the party adverse in interest today may be the key vote in a proposed plan tomorrow. Counsel represent the interests of their clients best when they consider all of the interests affected by the restructuring decision, interests that the court will also ultimately consider. The goal is to find common ground in formulation of a plan. Chief Restructuring Officers The most recent development in CCAA workouts involves the use of chief restructuring officers (CROs), frequently appointed in the initial stay order. The CRO is vested with responsibility to steer the insolvent firm through the negotiation for a plan and the restructuring process.

Judicial Discretion under the CCAA 147 CROs tend to be 'turnaround experts' that assume control of the corporation, replacing most of the functions of both the CEO and the directors. Algoma Steel, Loewen, and Consumers Packaging Inc. are all recent examples of CCAA cases that utilized a CRO.106 The appointment of a CRO can result in higher creditor confidence, particularly where creditors attribute the firm's financial distress to failures of governance. The CRO can also serve as a buffer between equity investors, directors, officers, and creditors, undertaking the often tough negotiations required for an effective workout. As a new participant, the CRO has all the advantages of a fresh assessment of the financial distress and the potential for refinancing and of a viable workout. Given that the CRO is a court-appointed officer, court supervision can ensure a measure of accountability that is normally a function of the relationship between the corporate board and senior managers. However, the CRO's objective is to maximize the value of fixed capital claims. Most of the CRO's compensation is performance-incentive driven, where performance is measured by return to creditors. Hence there is some risk that the CRO will fail to recognize or take account of the equitable investments of workers or other stakeholders. Moreover, CCAA orders tend to protect the CRO from liability that directors and officers face in respect of workers and others. Agency issues arise in terms of CRO decision making that can shift value to senior secured creditors to the disadvantage of longer term high-value creditors. These risks are mitigated somewhat by court supervision of the CRO's activities. However, the potential agency costs of CROs require further study. A CRO was successfully utilized in the recent Consumers Packaging Inc. (CPI) proceeding. CPI supplied most of the domestic glass bottle market in Canada. It was publicly listed on the TSX, but 63.6 per cent held by a shareholder who was also CEO and chair of the board. CPI faced problems that included pension deficit liability, aging capital assets, long-term fixed price contracts, and enormous increases in input costs. When the corporation began to experience financial distress in 2001, the corporate board struck an independent restructuring committee, recognizing the need for an independent assessment of the financial distress but preventing the control change and acceleration of financial obligations that would have been triggered by debt defaults or dilution of majority shareholder interest.107 The committee hired a CRO, who assumed operational control of the corporation and facilitated a complex debt arrangement and going-concern sale pro-

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cess of CPI's principle operating assets under the supervision of the CCAA judge. The workout ultimately generated a value of $61 million greater than CPI's estimated liquidation value. The purchaser assumed the pension plan deficit of $35-45 million and other employee obligations.108 Edward Sellers observes that the workout was facilitated by early recognition that an independent committee of directors and an independent CRO were needed to effectively assess and implement the corporation's options for a viable plan. The restructuring was driven by factors that included value maximization for almost all interested parties, preservation of supply relationships for ordinary trade creditors, preservation of more than 2,400 direct jobs, successor protection of the pension plan, and prevention of major disruption to the glass container and beverage market in Canada.109 Med-Chem and the Governance Role of Insolvency Professionals Med-Chem Health Care Limited illustrates that an effective understanding and balancing of the interests at risk is somewhat dependent on the way in which the issues are framed for the court by its officers and the parties.110 Med-Chem's CCAA application was converted to a receivership and bankruptcy proceeding. At the point of the bankruptcy sale, the court's concern for the integrity of the asset sale process (an important concern) outweighed concern for a process that engages in a balancing of interests. We do not know what the court's decision would have been if it had engaged in a balancing of diverse interests, nor can we know what the disposition would have been had the court had clearer evidence of the quantum and nature of the claims of workers and others as equitable investors. Clearer direction to the court's appointed officers may be required to ensure that a more optimal balancing of interests is engaged in before the issue comes before the court in a motion to approve a sale. Med-Chem was a medical laboratory operating through 500 collection and delivery sites and employing 890 employees, the majority of whom were represented by the Brewery, General and Professional Workers' Union (the union). Med-Chem experienced financial distress as the result of expansion in the mid-1990s, acquisition of significant long-term debt, and an inability to service that debt. It applied for CCAA protection in December 1998, and the court granted the initial order despite the opposition of secured creditors who were seeking early liquidation. In granting the protection of the CCAA, the court

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made reference to the interests of social stakeholders, particularly the interests of employees in preservation of their jobs.111 The claims by employees amounted to more than ten million dollars, making the unionized workers the largest group of unsecured creditors. A restructuring committee was struck, which included secured and unsecured creditors. From the outset, the parties anticipated new equity ownership as the principal restructuring mechanism. The monitor essentially observed the process and was not part of the efforts to restructure. On 30 December 1998, Med-Chem filed a plan of compromise and arrangement, but this plan failed to obtain the requisite creditor support.112 In January 1999, the restructuring committee received an offer from Canadian Medical Laboratories Limited (CML), conditional on numerous employee concessions. It entered into negotiations. The business was viable and the union was prepared to make considerable compromises on its claims. The chair of the restructuring committee, the Honourable Lloyd Houlden, described the union's efforts as highly constructive, but noted that without flexibility in the process and in the absence of the support of senior secured creditors, these best efforts were not successful.113 Further demands by CML were aimed at eliminating most jobs, and when this was not agreed to, negotiations were terminated. When the restructuring committee sought further bids, CML did not bid, advising the union that it did not want to deal with a unionized workforce.114 Subsequently, CML submitted a revised offer, the terms of which included discharging 450 employees. The restructuring committee rejected this offer. Less than two months after granting CCAA protection, the court would not extend the stay further and declared the corporation bankrupt. This represented a much shorter period than usual for a corporation of this size and number of sites to work out its affairs. The court then appointed the monitor as receiver and trustee in bankruptcy. The receiver assumed control of the assets and conducted a sale process.115 The receiver was interested in selling the business as a going concern because much of the value was in the 'corporate cap' given by the provincial government, essentially guaranteeing revenue. The court authorized the receiver to offer 'new' employment to existing employees deemed terminated by the bankruptcy and endorsed the receiver's request for an order that it was not a successor employer.116 The union agreed not to pursue a successor employer declaration in return for payment of some of its members' outstanding

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wage and vacation pay claims. The receiver also agreed on a withoutprejudice basis to abide by the collective agreement between the union and Med-Chem.117 Thus, workers agreed to invest further by continuing to work for the firm instead of searching for new employment. The receiver established a court-approved process and schedule to govern due diligence, solicitation, consideration, and acceptance of offers for an asset purchase.118 During this period, the union worked to develop an arrangement with Savage Walker Capital Inc. in association with the Teachers' Pension Plan. The parties had worked out a viable going-forward plan that included a five-year collective agreement, a contribution of $1 million of the union's money, as well as $10 million in compromise of wage and benefit claims. Savage Walker's offer was submitted to the receiver within the required time, but it was dependent on finalizing financing arrangements.119 The receiver refused to grant it two business days to complete the due diligence necessary to remove the financing condition. CML also made an offer of $105 million for a significant portion of the assets. CML was not acquiring the main laboratory that employed more than 450 workers; that operation was to be wound up and the workers discharged from their employment. CML's offer imposed conditions that included acquisition of the licence and corporate cap from the Ministry of Health prior to the closing date. This was a significant condition, given that much of the firm's value vested in the cap. CML's purchase price was also conditional on the full amount of the corporate cap being transferred, with heavy discounting if it were not. CML began to pressure the receiver to bring the bid process to conclusion before the deadline set by the court. Given the time-sensitive nature of the process, the receiver entered into negotiations and concluded a purchase and sale agreement that same day, subject to court approval. The receiver reported to the court that it was concerned that the offer would be withdrawn if the court did not make a decision quickly. It had considered the purchase price, likely recovery for creditors, potential claims against the estate, the assets to be purchased, and terms and conditions. The receiver reported that it was aware that the offer would result in numerous job losses. The receiver also advised the court that it had rejected the Savage Walker offer, which had included employment for substantially all of the existing employees, because the return was not quite as high for unsecured creditors, and because the offer was conditional on finalization of the financial arrangements. In the exercise of its own obligations, the re-

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ceiver could not risk losing a firm bid and thus the opportunity to satisfy creditors' claims. However, given the high interest in the corporation as a going concern, and particularly the guaranteed income from the Ministry of Health corporate cap, it is questionable that the receiver would have been left without a viable offer. An optimal outcome of the proceeding was likely distorted by strategic bargaining by a powerful party. Once the receiver accepted the deal, it was very difficult to retain the interest of potential investors in challenging that decision. When the receiver sought court approval of the asset sale, the union asked the court to exercise its discretion not to approve the sale and to direct the receiver to entertain an offer tabled by Savage Walker. This was essentially the same as the original offer but with the financing condition removed. Savage Walker's offer was arguably comparable if not superior to CML's bid. A group of landlords also supported the union's motion.120 The Savage Walker bid price had a stated value of $105 to $110 million.121 Unlike CML, this offer was not conditional on price adjustments because of anticipated claw-backs by the Ministry of Health. The proposal included retaining all of the employees, and a commitment by the union to waive all claims to outstanding wage and benefit arrears, thus enhancing the value of the offer by $9.2 million. The court, however, dismissed the union's motion and approved the sale to CML. In the Med-Chem case, the court applied the tests required to approve a sale of assets, but accorded them a narrow interpretation.122 One difficulty in assessing the Med-Chem process is that the union chose to argue many of the issues based solely on labour relations considerations. Thus, while the union argued that the receiver acted improvidently, this argument was based almost entirely on labour relations grounds. The union did not challenge other actions of the receiver that might have offered stronger evidence that the receiver had neither fully considered the interests of all creditors nor made a sufficient effort to obtain the best price. Most importantly, the offer the union was asking the court to compare was not the one submitted before CML's offer was accepted, but rather one submitted after the acceptance. The union's position was that as an officer of the court, the receiver had an obligation to act honestly and in good faith on behalf of all interested parties, as well as to deal with the property in a commercially reasonable manner. The union alleged that the court's approval

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of the CML offer would breach the court-approved receiver/union agreement. The Savage Walker bid was financially comparable to the CML bid, and in the union's view, it was superior when all of the relevant factors were considered. Both bids satisfied all of the claims of secured creditors. In addition, the going-concern value should have been calculated to account for savings to the estate of Med-Chem in costs that would not be incurred for termination of various supplier and landlord contracts. The Savage Walker offer did not breach labour contracts or labour legislation; employees, the community, and certain stakeholders would be put in a superior position while remaining creditors were in an equally advantageous position; and preservation of 455 jobs was of value to the community.123 The union argued further that the CML offer resulted in irreparable harm from closure of the central laboratory, and that there was no timely and effective remedy for the workers discharged as a result. The court's decision focused on whether it ought to interfere with the receiver's recommendation and not on a comparison of the two offers. The court held that when a receiver's sale is before the court for confirmation, the only issue is the propriety of the receiver's conduct. The court's function is not to step in and do the receiver's work. The court concluded that the receiver made every effort to obtain the best price, and it dismissed the argument that the receiver had acted improvidently because acceptance of the sale offer resulted in the dislocation of 455 people.124 It would not review the Savage Walker offer, because the receiver's views of the business matters were not to be 'placed under a microscope.' The court held that it should not reject the recommendation of the receiver except under the most exceptional circumstances, and in its view, the loss of 450 jobs was not an exceptional circumstance. The court held further that the receiver's assertion that the CML deal was equal to or better than the proposed Savage Walker deal 'brings any further inquiry into comparison of the deals to a halt.' To this point, the court was clearly concerned with protecting the process by which receivers conduct asset sales and with protecting the integrity of a bidding process. Ex post facto bids should not be used to justify judicial intervention. The court will examine the receiver's conduct in light of the information it had when it accepted the offer, and will be cautious in making determinations based on information that came to light after the receiver's decision. The facts in the Med Chem case are thus completely dissimilar from a case in which two compet-

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ing bids were submitted, and the receiver chose the one that would lead to massive loss of employment. No issue of the integrity of the bidding process would arise in such circumstances and the court would be able to deal directly with the balancing of interests by a receiver in considering two such bids. Unfortunately, the sequence of events in the Med-Chem proceeding meant that by the time the court was asked to make a decision on the asset sale, other values, such as upholding the integrity of the process by which receivers sell assets, had to be taken into account. This consideration took precedence over the balancing of diverse interests of parties in the sale decision. While the Savage Walker bid was not an eleventh-hour offer in the traditional sense, it was nevertheless an eleventh-hour bid in that the financing condition was lifted after the other offer was accepted. There are good policy reasons for refusing to allow an unsuccessful bidder to overturn acceptance of another offer by changing its offer. However, the court's decision goes beyond this, and appears to return to a much narrower understanding of the interests that must be considered and balanced by the receiver. It would have been helpful if the court had clarified that if the issue had come before the court in the form of a pure competition between two offers, the court would have seriously considered whether the receiver had balanced all the interests of and prejudice to stakeholders. Such clarification may have avoided the impression that the court was declaring that workers' losses should be considered exclusively in the labour relations forum. While the court properly deferred the question of unfair labour practices to the Labour Relations Board, it did not indicate that the issue of loss of human capital investment is relevant to insolvency and bankruptcy proceedings. It declined to consider whether the alleged labour violations created exceptional circumstances, yet curiously, its deference to the labour relations forum had not prevented the court from earlier granting the receiver's motion for an order that it was not a successor employer for labour relations purposes. The court's granting of these types of orders to protect receivers from the ordinary consequences of collective agreements and labour relations law, and the deference it exhibited towards labour relations tribunals when asked to assess the behaviour of the receiver, requires further explanation. The union immediately moved to set aside the order before the Ontario Court of Appeal. The Court of Appeal dismissed the stay motion. Based on the record before it, the Court of Appeal engaged in

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the appropriate decision-making process. Mr Justice Laskin held that the judge had not exercised his discretion unreasonably nor had he committed an error in principle.125 The Court held that 'deference to the Receiver overlaid with deference to the court makes it exceptionally difficult for the Union to succeed in this court.' Given that the record before it indicated that the receiver had considered the interests of all the parties and had tried to obtain the best price, the Court of Appeal's reasoning makes sense. Myers and Sellers point out that the appeal was heard on the same day as the sale was approved, because the receiver's intention was to close the transaction immediately following the court's endorsement.126 The Court of Appeal's decision was rendered at 11:30 that evening. They suggest that the late hour and time pressure meant that the Court of Appeal was unable to give the issue of 'social stakeholders' full consideration, and that the issue of when and how to effectively deal with social stakeholder concerns remains open to fuller appraisal in Canadian insolvency proceedings. They suggest that in an optimal approach, the court should issue orders giving relief in favour of social stakeholders where such relief does not significantly or materially prejudice the interests of traditional creditors. However, there is a point in the going-concern phase of the proceedings at which the rationale for such relief diminishes. Med-Chem illustrates that certain factors in the current regime may operate as limits to the courts' willingness or ability to consider the equitable interests of diverse stakeholders. The integrity of the sale process is one such limit. While the court may have correctly deferred to the receiver to protect the integrity of the sale process, its conclusion that the issues raised by the union related exclusively to labour law failed to recognize the interest and investment of workers as both fixed capital and equitable claimants in the bankruptcy proceedings. At best, Med-Chem represents an uneven application of the concepts of public interest. Med-Chem also illustrates the very fine line between effective case management and the need for flexibility in the process. While most would agree that a debtor corporation should not be allowed to languish in CCAA proceedings, the short time frames imposed by the court in the face of multiple bidders and potential investors was almost unprecedented in CCAA applications for an enterprise of this kind.127 In less than two months, the corporation was declared bankrupt. If the aim is to maximize enterprise value, where there is potential for the parties to negotiate a workout acceptable to all debt, eq-

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uity, and equitable stakeholders, the process must be flexible enough to allow the parties to try to reach consensus. Pacing the proceedings is particularly important where, as in Med-Chem, there was enormous potential for a viable business plan. Where time frames are too tightly imposed, the process will work against those stakeholders who must build some consensus in order to put together a restructuring package. Industry investors are at a competitive advantage; they know the industry, and their established lenders are also aware of the commercial potential of purchase of a competitor's business in terms of both enhancing value and reducing competition. U.S. distressed debt purchasers (vulture funds) can sustain some losses because of the size and variety of investments and the ability to spread risk. They can act quickly in restructuring processes to offer funding and secure priority. In contrast, pension funds or other institutional investors with more rigorous due diligence requirements, must seek approval decisions at multiple levels of the organization. Thus, frequently they can only give expressions of interest or make conditional offers. Their decision-making processes, while protective of pension and other beneficiaries, are not particularly conducive to the insolvency context, in which time is of the essence. This is particularly so because such investors cannot inject capital unless there is fairly low risk to the investment. Since insolvency creates additional risk, the due diligence in such cases is even higher and thus requires more time. Given that these investors are often the only source for workers to obtain investment funds, inflexibility in the process will necessarily lead to outcomes that favour industry investors. While industry investors are an important source of funds, rigid time frames should not act as a bar to investors who are more likely to recognize the interests of workers, local suppliers, and other stakeholders. It is equally important that pension funds and similar institutional investors develop mechanisms to expedite decision making if they are to consider such investments. Where parties are seeking to establish economic interests not previously expressly recognized by the court, such as human capital investments or investment in local community infrastructure, they will be unlikely to receive the full attention of the court absent some quantifiable evidence of this interest. The principles for calculation of this interest suggested in chapter 3, provide one means to assist the court in fully appreciating their interests. Generally speaking, the court in its supervisory capacity must monitor the progress of negotiations for

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a plan of arrangement. Failure to recognize the organic nature of these processes, particularly where there is a viable business at stake, will lead to firm failure. As the federal government conducts its 2002-3 review of the CCAA, there is considerable debate regarding whether the role of the monitor should be codified. The issue is frequently cast as whether the debtor's auditor or financial adviser should continue to be allowed to act as monitor. At the heart of the debate, however, is defining the scope of the role. The monitor is considered an officer of the court, and there is a general expectation by stakeholders that the monitor will assess the process with regard to the interests of the general body of creditors. However, where the monitor has a long-standing relationship with the debtor, it may be difficult for it to perform this role. Moreover, where the monitor is giving restructuring advice to the debtor, creditors are unlikely to believe that it can objectively assess a plan for the court. Senior creditors have the resources to seek independent assessments of the proposed plan, so any conflicts of interest will likely disadvantage small creditors and the multiple stakeholder groups discussed throughout this book. The role of the monitor needs to be clarified to enhance confidence in the system. A separation of roles may be necessary, yet the present duplication is aimed at saving costs in the restructuring exercise. The debtor often cannot afford both a monitor and a restructuring adviser. In reality, however, costs are likely shifted rather than saved, because creditors who do not have confidence in the independence of the monitor hire their own expertise. Creditor committees might provide one solution to this problem. However, the cost consequences of this option deserve further study.

5 Algoma Steel Corporation: Recognition of Human Capital Investments

The CCAA is designed to be remedial legislation ... Algoma itself, its workers, unionized and salaried, Dofasco, the banks and other debt holders and creditors, and the governments of Ontario and Canada ... without the co-operative foundation building of all of you ... the collapse of Algoma would have had a devastating effect. Justice Farley, Ontario Court (Gen. Div.) Algoma Plan Sanctioning Hearing, 19921 The cost of failure ... would be immense, the benefits of success are obvious to those directly affected - employees, shareholders, pensioners, creditors, but as well, there is the positive multiplier effect for the community ... Chief Justice LeSage, Ontario Superior Court Algoma Plan Sanctioning Hearing, 20012

Algoma Steel Inc. has utilized CCAA proceedings twice, in 1991-2 and in 2001-2. Algoma Steel provides an important example of the CCAA process in its recognition of the interests of stakeholders other than traditional creditors and shareholders. It also demonstrates that a successful proceeding is dependent on the cooperation of all parties. There were important differences in the financial distress and stakeholders involved in the two proceedings, which made a difference to the outcome, including claims to a proportionate share of the value and governance of the corporation after the CCAA process was completed.

158 Creditor Rights and the Public Interest The 1991-2 CCAA Restructuring of Algoma Algoma Steel's insolvency in 1991 was due to a huge long-term debt load, poor governance practices, increased global competition, removal of trade barriers, unfavourable exchange rates, competition from plastic and aluminum substitutes, reduced domestic consumption, and rapid technological change in steel production. Market prices were flat, yet Algoma required substantial capital investment in order to become competitive in world markets. Its parent company, Dofasco Inc., announced that it would no longer provide financial assistance to Algoma, and as a result it became insolvent. The corporation sought protection under the CCAA in February 1991. At the time, its debt was $700 million, with $75 million in annual carrying costs. A shutdown of Algoma would have meant the loss of 6,000 direct jobs and an estimated 23,000 spin-off jobs in the northern Ontario community of Sault Ste Marie. Lost revenues and displacement costs in terms of training, compensation, and lost tax base to governments were estimated at $550 million. At the time of the filing, labour relations were strained as the result of a 112-day work stoppage in 1990 due to dispute regarding downsizing, contracting out, and the question of indexing of pensions.3 The initial restructuring plan proposed by Dofasco included shutting down three out of four of Algoma's production lines; closing its iron ore mine and sintering facility; cutting 3,500 jobs immediately, with additional substantial workforce reductions; reduction of the company's $250 million pension liability by converting most of the liability into shares; and seeking exemption from environmental cleanup liability estimated at $75-200 million.4 The union representing the workers, the United Steelworkers of America (USWA), opposed this plan. The initial proposal highlighted the problem of workers and the community being required to bear a higher degree of risk in corporate restructuring than equity holders, managers, or institutional lenders. Massive downsizing, reduction in product lines, little capital expenditure, and reduction of liability through a conversion of debt into equity left a number of stakeholders highly vulnerable. Employees were asked to take substantial wage cuts in exchange for minority shares, without being given any voice in decision making at the board or the shop-floor level. At the same time, more than one-third of the workforce was to be cut, with additional cuts the following year. Employees

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were being asked to contribute their human capital and equity capital in exchange for a work environment that continued to be hostile to employees and high risk in terms of job security. The proposed exchange of pension liability for share holdings would exacerbate this situation, tying up more of the workers' human and equity capital in the firm. Algoma wanted to reduce its exposure to liability under the provincial government's pension benefits guarantee fund, and the proposal would have shifted risks previously borne by the corporation to the workers, placing their future income at risk as well. The community was also asked to acquire a higher portion of the risk. There were additional costs to the municipal tax base from reduction of operations, loss in purchasing power, loss in taxes, and an increase in the number of people likely to become dependent on municipal services such as social assistance. The community would also bear the risk of any outcomes from the waiver of environmental clean-up liability that the corporation was seeking. USWA's previous experience with worker buy-outs in the United States had taught it that without a change in governance practices to allow workers to participate in business decisions, they are left with much of the risk and little protection. The union announced that it would prepare an alternative to the corporation's proposed plan, and the court extended the stay and authorized further temporary financing of $40 million. This financing was secured by receivables and inventories, and by guarantees of $10 million each by the Ontario government, Dofasco, the bank, and the workers (funded by wage and salary reductions from July to October 1991 which were placed in a trust fund). The union took leadership in bringing the stakeholders together. This was extraordinary, in that most worker buy-outs are typically initiated and coordinated by managers, with employees buying in. USWA used industry and banking experts with experience in American worker buy-outs to craft an alternative restructuring proposal based on a sound business plan. The union's objective was twofold; to create wealth for investors, but equally, to expressly set an objective of sustaining jobs for members. The union effectively employed its negative bargaining power, the withholding of its agreement to any restructuring plan that would completely devastate its workforce, to persuade parties to use its restructuring strategy as the basis of discussions. While far from enamoured with the union's initiative, the major creditors agreed to participate because it was a better option than bankruptcy. Algoma

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needed government guarantee of an operating line of credit above the $180 million already secured, and the banks understood that the then NDP government would not consider a guarantee without the union at the bargaining table.5 A negotiating protocol was established and a co-determination structure agreed to after the intervention of the court, the case management judge, Mr Justice Farley, exercising critically important judicial oversight to ensure an expeditious process. Court-Ordered Mediation as a Key Element in the 1991-2 Restructuring The court expressed strong support for the CCAA's objectives and was forceful in encouraging the parties to come to the bargaining table and negotiate. When negotiations stalled, the court ordered mediation. Parties to the negotiations had conceded to the court that the proposed business plan was feasible, and that outstanding issues related to the financial contributions to be made by the various key stakeholders. The court ordered the parties to meet with the (then) Mr Justice Adams in a process that Justice Farley described as 'akin to court annexed alternative dispute resolution,' because of the 'special circumstances of the vital importance of Algoma to the essential viability of Sault Ste. Marie as a major Northern Ontario Community.'6 Success of the process was due in part to the skills that Justice Adams brought to the mediation, assisting the banks and USWA to craft an outcome acceptable to all stakeholders. The multi-faceted negotiation/mediation process also included the intervention of the Ontario premier. The positive intervention of a provincial government sympathetic to workers and to sustaining northern communities was important to the process. The result of two intensive weeks of mediation was an agreed plan of arrangement that had high buy-in by the parties. Subsequent meetings of shareholders and creditors resulted in votes of greater than 95 per cent support for the plan. The court approved the plan of arrangement on 16 April 1992.7 The key role played by the court in encouraging the parties to use all the dispute resolution mechanisms available is evidence of the effectiveness of the CCAA case-managed process. Mr Justice Farley has observed that a significant aspect of the court's involvement in Algoma was its ability to encourage the parties to negotiate and to exert every effort to reach a compromise, using court-involved mediation to assist with dismantling traditional walls between parties such as bankers

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and union representatives.8 While normally the court would rely on the consent of parties to use alternative forms of dispute resolution, there may be occasions in which it is willing to order mediation. The use of court-ordered mediation in Algoma Steel was significant in that it set a precedent. Not only was this the first time the court had ordered an alternative dispute resolution mechanism in a restructuring, but its use recognized the legitimacy of the involvement of workers and their unions in the actual negotiation of the plan. The court's signal to Algoma and its senior lenders in respect to consideration of workers' interests set the stage for cases such as Anvil Range and Red Cross, discussed in following chapters. Co-determination as an Integral Part of the Restructuring Plan The terms of the 1991-2 plan were elaborate, involving a partnership arrangement between workers, managers, creditors, and the Ontario government as loan guarantor. The corporate restructuring was based on eight principles: Algoma was to restore all lines of business to profitability; employees were to become majority shareholders in the corporation; the government would enact legislation to facilitate worker ownership; there was to be an injection of capital into upgrading the plant; the government would provide bridge pensions to facilitate workforce reduction; Dofasco would pay a share of the restructuring; Algoma would become a 'responsible corporate citizen' in respect of the environment; and government funding would be forthcoming to upgrade employee skills.9 The premise was that the short-term costs of economic transition were considerably less than the long-term cost of major lay-offs, employee displacement, loss of equity, and creditor losses. Debenture holders other than Dofasco received new preferred shares in a subsidiary of Algoma Steel, Algoma Finance Inc., for 60 per cent of their secured claims and common shares in Algoma for the balance of their interest. The shares of Algoma Finance were secured by a floating charge on property and assets of the corporation and agreement by Algoma to purchase the preferred shares if specified default events occurred. Specified unsecured creditors and preference shareholders received common shares under the plan, and amounts owing to preferred creditors as well as specified trade suppliers were reduced. Workers and salaried staff took a 14.5 per cent decrease in annual salaries, as well as cuts in vacation time. The employees acquired a 60

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per cent equity ownership in the corporation. In the first five years of restructuring, all employees who worked at least 1,800 hours received an equal number of shares, regardless of their wage rate. Disposal of the shares during this period was restricted to the greater of five years or permanent separation from the corporation through resignation, retirement, or permanent lay-off. Special employee voting shares carrying governance rights, including the right to approve fundamental business decisions, were held in two trusts by USWA. This accorded the union the voting power requisite to ensure a genuine shift in governance structure. Fundamental decisions included sale, merger, or transfer of the business or assets; issuance of additional shares that would dilute the equity investment of employees to less than 50 per cent; any major departure from the business plan not supported by a super-majority of the board; and the purchase of any business or asset outside either the steel business or the communities of Sault Ste Marie or Wawa. Workers were also given voting rights in respect of amendments to the articles or by-laws in relation to election of directors; 50 per cent participation rights on any CEO search committee; a USWA representative given access to corporate board materials and the right to observe at board meetings; the right to make presentations to the board on matters tabled by a union nominee director; and access on a confidential basis to all financial and operating data.10 The debt restructuring through conversion of debt to shares and debt forgiveness reduced the corporation's annual interest charges from $75 million to $11 million in one year.11 The restructuring plan focused on increasing sales by implementing an extensive capital investment program of $500 million over five years, plus $45 million capital investment to meet environmental standards. Dofasco remained liable for half of the defined benefit pension plan liability in exchange for a release from further pension liability. Algoma also secured 'infant industry protection' from Dofasco through non-competition and product purchase agreements. A new thirteen-member board of directors included five union nominees, the CEO or nominee, and seven independent directors selected by special committee and acceptable to both USWA and the bank debenture holders. Restructuring at the shop-floor level took the form of vesting day-to-day control of work operations in the hands of worker self-directed teams, reducing levels of supervision accordingly. The express goals were to make production safe; to enhance the skills, responsibilities, and accountability of workers; and to create efficien-

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cies. A joint steering committee of union and senior management developed a workplace participation program to redesign the workplace. Management was to have carriage of discipline, yet there was to be worker/manager co-determination in decisions relating to training, problem solving, cost reduction, and new technology.12 These governance changes were incorporated into the corporate articles as well as the collective agreement. The explicit objectives of the corporation were to undertake decision making having regard to the goals of economic security, empowerment of workers, improved productivity and quality.13 This gave formal recognition to the human capital investments of the workers, according these investments a status comparable to that usually given exclusively to equity capital investors. When the tough decisions were subsequently made about capitalization, dilution of worker shareholdings and closure of the rolling mill plant, there was high buy-in by workers and managers.14 The Algoma restructuring plan expressly recognized that Algoma workers were uniquely situated to create value for the corporation's stakeholders. The aim was to have workers, as majority shareholders and key participants in governance of the corporation, make the corporation more competitive. McCartney points out that the central challenge was to negotiate a fair sharing of the 'pain' and 'gain' under a sound business plan.15 Cooperation and leadership by the union, workers, and managers, and a willingness to redesign the workplace, were crucial to increased productivity and reduction of costs. At the time of the worker buyout, the value of shares was a few cents per share. By early 1998, shares were trading at between five and eight dollars per share.16 The corporation experienced strong economic and efficiency gains for seven years. The turn around may be explained by the combination of a sound business strategy accompanied by governance changes. Recognition of Community as Stakeholder in the 1991-2 CCAA Proceeding While there was no formal participation of community stakeholders in the 1991-2 CCAA proceeding, the Algoma Steel case does offer some insight into how community interests might be recognized in the restructuring process. Given the enormous impact that the closure would have had on Sault Ste Marie, the community was very concerned. When USWA proposed its alternative plan, community interest was

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formalized by the creation of a non-profit organization called Algoma Community Action Team (CAT). The union's proposal provided a concrete strategy around which community members could mobilize.17 The non-profit organization involved local business and community members. The company, the local government, and the union each donated $5,000 to allow CAT to commence its work. Within a short time period, more than 22,000 community residents had taken out memberships, donating $165,000 to help CAT lobby and assist with the restructuring negotiations. CAT did not automatically endorse the union's proposed plan, although it did eventually accept it in the fall of 1991. CAT's significant contribution to the process was that it secured information from Algoma on the source of the financial distress and disseminated it to the public, independent of the corporation and the union. The organization mobilized the community to pressure various levels of government to support the restructuring, including delegations to politicians and documentation of the economic and social harms caused by the failure of U.S. steel plants. CAT never sought formal participation rights, and a live issue is whether the court would have granted such rights had it been asked, perhaps in the nature of intervenor status as suggested in chapter 3. CAT's activism encouraged acceptance of the notion that communities can play a role in the restructuring process and are in some circumstances able to organize themselves in such a way as to have their diverse interests represented by one voice. The 2001 CCAA Application of Algoma Steel Corporation In the final quarter of 1998, Algoma started to suffer financial losses again, and by April 2001 the corporation was once again insolvent. In the first half of 2001, Algoma lost $200 million, and had an accumulated debt of more than $560 million. It filed again for protection under the CCAA, roughly a decade after its last application, and the Ontario Superior Court of Justice granted a stay of proceedings in April 2001. Algoma's financial distress in this instance was symptomatic of the North American steel industry: twenty-five steel corporations have filed or emerged from restructuring proceedings in the past three years.18 The difference between the 1991/2 restructuring and the 2001 insolvency lay in the source of Algoma's financial distress. The corporation had managed to develop an efficient operation over the 1990s. Many of the prior inefficiencies in management structure,

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decision making regarding production and innovation, and outdated capital equipment were eliminated, and the corporation had become competitive within the North American steel market. Its Direct Strip Production Complex (DSPC) is a highly productive thin slab caster and hot strip mill facility with enormous potential. The corporation's efficient operations, however, face difficult competitive pressures, particularly from offshore dumping, exacerbated by the market downturn and economic repercussions of the September 2001 attacks on the World Trade Center.19 A key source of Algoma's renewed financial distress was the high financing costs incurred in building the DSPC and the slower than anticipated ramp-up. The corporation also had unfunded pension liabilities of over $650 million. There are 8,000 pension beneficiaries. While Ontario has a Pension Benefits Guarantee Fund (PBGF) established under the Ontario Pension Benefits Act, its total assets at the time were only $200 million. At the time of filing for CCAA protection, Algoma had 3,900 employees accounting for 20 per cent of full-time employment in Sault Ste Marie. Twenty-four per cent of common shares were held by employees and 200,000 employee voting shares were held in trust by USWA. The monitor appointed under the initial stay order provided the court with information regarding the social and economic consequences of Algoma's potential demise. Firm failure would result in the loss of an estimated 11,000 jobs, including spin-off and unemployment income offsets.20 A shutdown would have serious economic consequences for local businesses for which Algoma was the principal or sole customer. The monitor reported that the income loss to Canada would be an estimated $830 million in the first year if Algoma were to become bankrupt. It estimated that there would be enormous costs to the municipal tax base because of forced early retirements and the loss of young and middle-aged workers, who would seek work elsewhere. It predicted numerous social harms from the loss of health, municipal, fire, and other services and the resultant increase in adverse health effects, family breakdown, and financial burden on workers and their families. Its liquidation analysis was that operating lenders would receive 100 per cent recovery, noteholders 85 per cent, unsecured creditors would receive no value, and winding up of the pension plan would result in a $400 million shortfall not covered by the PBGF.21 The CCAA stay was extended several times. As with the first restructuring, the negotiations for a workout involved multiple issues and parties. The supervising judge under the CCAA, Mr Justice Farley,

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once again played a key role, resolving procedural and substantive disputes as they arose, and conducting an intensive dispute resolution process that resulted in a proposed plan that stakeholders could support. A crucial issue was finding a source of capital that was less costly than the long-term debt currently held. The level of equity ownership, if any, that the employees would be able to retain, and resultant governance structures had also to be resolved. The 2001 Flan of Arrangement and Reorganization After almost nine months under CCAA protection, on 19 December 2001, Associate Chief Justice LeSage of the Ontario Superior Court sanctioned the plan of arrangement for Algoma Steel.22 The plan involved compromise of claims and a reorganization of its capital and governance structure. The affected claims were those of the noteholders, the municipality, indexed pension benefit creditors, non-indexed pension benefit creditors, and unsecured creditors. The plan did not affect the claims of the banks and other senior secured lenders, including the operating lenders pursuant to the credit facility and DIP credit facility; the claims of secured creditors other than the noteholders and pensioners; the claims of the monitor, the directors, and specified legal and financial advisers; CCAA proceedings costs; claims under personal property leases not terminated; claims for indemnity by directors; non-pension-related employment claims; Crown claims for source deductions; and claims of the chief restructuring officer. The monitor assisted in developing the plan, endorsed it, and in its report set out the future risk factors, including economic cycles for creditors to consider, industry conditions, leveraging issues, competition, currency fluctuations, and expected cost savings. Noteholder claims were compromised. In exchange for the $349 U.S. million, noteholders received new notes issued 1 January 2002 of $125 U.S. million at 11 per cent interest due 2009 and $62.5 U.S. million at 1 per cent due 2030 pursuant to a new note indenture distributed on a pro rata basis.23 The reorganization allowed for the creation of new common shares, with 20 million new common shares issued initially under a new common share pool, 75 per cent to noteholders and 5 per cent to unsecured creditors, to be shared pro rata. The remaining 20 per cent (4 million shares) of the new common shares were to be distributed to the 3,900 employees on an equally shared basis, within thirty days of implementation of the plan. The current authorized

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capital was deleted and all authorized common shares cancelled, with no economic value assigned to them. Thus employees lost their 24 per cent holdings of common shares held prior to the workout and all other shareholders' interests were eliminated under the old governance structure. There are no longer shares held in trust by the union. The new common shares provide entitlement to notice of and attendance at general and special meetings, with one vote per share. All of the new common shares are to be freely tradable following the 2002 plan implementation date, including those held by employees, and the corporation was to use its best efforts to list the shares on the TSX (this listing became effective in February 2002). The 2001 plan contains replacement pension compromises whereby Algoma's pension plan liabilities are restructured, reducing the projected pension cash costs by $124 million. Each of the existing pension plans is divided into two separate plans, an 'active plan' and a 'retiree plan.' Current recipients of pension benefits will be subject to the retiree plans. The retiree plans will be wound up at some point in the future, with the Ontario Superintendent of Financial Services responsible for the administration of the plans until they have been completely wound up. Payments will be made from the PBGF to or for the benefit of pensioners and beneficiaries to the extent necessary to provide the PBGF guaranteed benefits specified under the Pension Benefits Act. The Ontario government will make loans to the PBGF to fund these guaranteed benefits in the event that the PBGF is unable to make payments. The difference between the amount of pension benefits payable under the predecessor Algoma pension plan and the PBGF guaranteed benefits will be paid by Algoma, either from general revenue or from a pension plan. Thus pensioners are likely to continue receiving current pension benefit levels, without future cost of living or other indexing increases. In respect of the active plan, Algoma will continue to administer the pension plans of active employees but negotiate changes to early retirement and indexing in the collective agreements. The obligations of Algoma in excess of assets will be secured, up to a maximum of $100 million, by a charge on Algoma's fixed assets subordinate to the security for the new credit facilities, the new notes, and all charges for any borrowed debt in the course of business. Such security will terminate on termination of the new credit facilities and can be enforced only on Algoma's insolvency and wind-up.24

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Unsecured creditors with claims greater than $2,500 would receive a pro rata share of 5 per cent of the new common share pool. Unsecured creditors with claims of less than $2,500, or those with greater claims who elected, received cash in the amount equal to the lesser of $2,500 and pro rata share of a maximum of $2 million. The municipal government would receive $5 million in equal instalments in December 2002 and 2003 as compromise of its $7.4 million claim for unpaid municipal taxes, secured by a lien on Algoma's real property. The plan specifies that the corporation was to pay all amounts owing under the Income Tax Act or similar legislation within six months of the plan's approval. Current equity holders were not entitled to any compensation under the plan. The federal and/or Ontario governments were to conclude arrangements for employee training, as a condition to implementation of the plan. The plan was also dependent on the federal government providing a $50 million loan guarantee to ensure liquidity as Algoma emerged from CCAA protection. The plan discharged all claims against directors and officers of Algoma, the monitor and CRO, and their financial and legal advisers, including statutory claims, other than unaffected claims or claims arising from a final judgment finding fraud, wilful misconduct, or gross negligence, or claims for which the CCAA does not allow compromise for directors.25 The plan was conditional on new collective agreements being ratified before 31 December 2001, achieving $153 million in cost cuts over two and a half years. The collective agreements negotiated specify a 15 per cent wage cut for a period of six months, with the wage reduction moving to 9 per cent for the following six months, 7.5 per cent for the next six months, and 6.5 per cent for the final six months before wages returned to their original levels. Provision was made for a cost of living adjustment in the last eight months of the agreement. The average reduction was 7.25 per cent over all over a thirty-two-month contract, with the caveat that $10 million savings may be returned to employees in 2004 and 2005 if all accrued interest owed to noteholders is paid up to date.26 The cost savings include temporary wage and benefit reductions, temporary vacation and vacation bonus reductions, and changes in the structure of early retirement pension benefits to reduce funding costs. The wage reductions applied to both unionized and non-union employees. The new collective agreement contemplates a reduction of 350 jobs over the life of the agreement, at all levels of the corporation, to be effected in a fair and equitable manner. As the situation developed, the number of early retirees greatly exceeded the

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contemplated job reductions. The collective agreement implements a retiree transition program. It also preserves the internal joint governance on the shop floor, joint committees, and language for pay continuance during lay-off.27 The new collective agreements will expire in July 2004 or at the option of USWA on ninety days notice where the debtor is acquired by new majority owners of common shares or on sale of substantially all of the assets. Algoma successfully avoided bankruptcy and liquidation after more than eight months of CCAA protection and numerous court orders to facilitate the process. The affected classes voted overwhelmingly in support of the plan, including 80.3 per cent of the 106 noteholders representing 79.9 per cent in value of the noteholder creditor class; 93.8 per cent of the 1,110 indexed pension benefits creditors representing claims of 94.8 per cent of almost $279 million value; 99.3 per cent of the 672 non-indexed pension benefit creditors representing 99.5 per cent of the $61 million value of their claims; 100 per cent of the unsecured creditors; and 100 per cent of the municipal government as a creditor class. The chief restructuring officer advised the court that all affected stakeholders had made compromises and that the plan maximized value for all parties.28 The court, in sanctioning the 2001 plan, held that it was in the best interests of all the stakeholders, and that a substantial public interest favoured approval of the plan. Governance under the 2001 Plan of Arrangement The 2001 Algoma Plan includes reorganization under the Canada Business Corporations Act.29 A board of three to ten directors will replace the existing board of directors and the joint governance provisions of the corporate articles have been deleted. There are two key governance changes, those with respect to the noteholders and the employees. The noteholders are entitled to nominate up to seven new directors. The final plan fixed the number of directors at ten until the next general annual meeting and the new directors took office on the plan implementation date in 2002. The securing of board positions is not unusual following an insolvency workout. For the solvent corporation, creditors generally exercise a governance function by their pricing and terms of debt.30 Operating lenders exercise a monitoring function, because of re-evaluation processes for loan renewals, access to information about cash-flow and expenditures through provision of banking services, and early warning sig-

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nals on payment default.31 In post-insolvency restructuring periods, 'exit' has devastating consequences for the corporation. Secured creditors can utilize the threat of exit to force governance change during negotiations for the workout. That is what happened at Algoma, notwithstanding the fact that the insolvency was not attributed to the governance structure but rather to long-term debt load and market and currency fluctuations, as discussed above. The price of the compromise for noteholders as the senior affected creditors was a majority of seats on the corporate board. Arguably, they were able to use their bargaining leverage to extract a premium in debt terms and percentage of equity ownership for their support of the plan, because they would receive 85 per cent realization on liquidation and because they were not 'high-value' creditors in the sense of having a long-term interest in the corporation's viability. The noteholders insisted as a condition of the workout that the co-determination governance provisions be eliminated from the corporate articles. As the new majority shareholders of the corporation, they wanted the unfettered right to control management of the corporation. Where an insolvent corporation is essentially sold to creditors in compromise of their claims, they acquire a heightened interest in governance post-plan implementation that is not satisfied through the pricing mechanism of debt. In the Algoma workout, the noteholders became the recipients of fixed returns through the new notes. They also become residual risk bearers, by virtue of the size of their equity ownership. By obtaining board membership, the nominees of the noteholders also acquire a level of statutory and other personal liability that should necessitate fairly rigorous governance participation. This is a factor favouring the monitoring of managers and of corporate performance. It remains to be seen, however, whether Algoma will fall prey to more traditional governance decisions that fail to recognize the equitable interests of workers, small trade suppliers, and community stakeholders. Once the collective agreement expires, financial decisions may involve wholesale labour shedding, without regard to the investments of these stakeholders or to the long-term viability of the firm. This situation highlights the relevance of the governance protections employees were able to retain under the 2001 plan. The union had little bargaining leverage during the 2001 plan negotiations, primarily because of its concern for the 8,000 pension beneficiaries whose interests were at risk, as well as the current job security of members.

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Moreover, the union recognized that for Algoma to survive and remain competitive in global markets, additional capital expenditures are needed, and capital will necessarily be raised through equity as opposed to debt. Bargaining for a majority stockholding would at best have been a very temporary measure. Under the 2001 Plan, the employee voting shares held in trust by USWA and many of governance rights associated with them were eliminated. The union lost the veto powers it had in terms of fundamental changes to the business plan. However, some residual governance rights were retained. The plan specifies that 'three nominees of USWA will be proposed by management of Algoma for election to the Board of ten directors.'32 The current board is thus comprised of three directors nominated by the USWA, and seven directors nominated by debt holders. The plan also specifies that any new CEO will be recommended by a search committee of the board of directors, of which at least one director will be a union nominee. Any decision by the corporate board to sell or close a material business of Algoma, or material assets capable of being operated as a separate business, will be preceded by a full study of viability, value, and potential buyers, with input from advisers retained by USWA and paid for by the corporation. These terms are enshrined in the new collective agreement, ratified December 2001, but not in the corporate articles. The collective agreement also specifies that the corporation will continue to provide USWA with confidential information necessary for it to carry out its functions under the agreement.33 The company will provide each unionnominated director with the legal and financial advice reasonably required to carry out his or her duties. The collective agreement also specifies that the corporation will not permanently close the 106" /166" mills if any two of three union-nominee directors oppose such a move, and similarly, that the corporation will not make a decision not to proceed with the planned blast furnace capital expenditures if two of three union directors are opposed. These protections were established in order to prevent the noteholders, through their nominee directors, from moving immediately to sell off the valuable assets or failing to make necessary capital expenditures to remain competitive. Implementation of the collective agreement was also conditional on the corporation securing a loan guarantee of $50 million from the federal government and other definitive agreements with financial institutions to meet the corporation's projected financing needs. This condition was specified as for the benefit of the union

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and thus the union will determine on a reasonable basis whether it has been achieved.34 The protections offered are short term, for the life of the collective agreement. They do temper unfettered managerial discretion, with the hope of devising long-term business strategies that promote the multiple objectives of enterprise wealth maximization and recognition of diverse investments. However, governance protection has not been enshrined in the corporate articles, resulting in considerably less protection for workers' investments than existed previously. All of the co-determination structures in terms of joint decision making on production and innovation remain.35 The collective agreement specifies that the corporation remains committed to the joint decisionmaking process, and the joint steering committee (JSC) will continue its governance function in respect of operations. The JSC is to be involved in defining job tasks and reductions, ensuring that where possible they are accomplished by attrition. If there is a dispute on such issues, management's final decision will not be implemented until the union joint-chair of the JSC has the opportunity to review it with the board of directors.36 The collective agreement also specifies that workforce reduction will be accomplished having regard to criteria such as health and safety. Departmental steering committees will continue to be responsible for monitoring all new job combinations. Thus, the shop-floor and day-to-day governance rights have been largely preserved. The issue is whether these will be sufficient to sustain the governance changes effected under the 1991-2 restructuring, or whether the loss of governance rights at the corporate board level will negatively affect workers' future human capital investments. There is also an issue as to whether preservation of this level of co-determination will act to expropriate that investment in the absence of protection at the board level or in the corporate articles. Successful emergence of a corporation post-insolvency requires future human capital investment by workers. Thus there is a certain amount of interdependence of the stakeholder groups as Algoma emerges from CCAA protection, particularly in monitoring management of the firm. This monitoring will extend beyond board membership to employees on the shop floor, the union, and the operating lenders. The size of capital claims of secured creditors resulted in enormous bargaining leverage in the 2001 workout. Given that on liquidation, operating lenders would have received 100 per cent realization of their

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claims and noteholders 85 per cent, there was little upside gain for these creditors. All the losses of firm failure would have been borne by the unsecured creditors, the pensioners, employees, and the community. This allowed the extraction of most of the future upside potential of the firm and a governance structure in which the noteholders have overwhelming majority of seats on the board and majority of common shares. The employees retain 20 per cent of the equity, but it will be widely held with no trust to allow the collective exercise of votes. Given the bargaining inequities, USWA likely obtained the best outcome possible in the circumstances. The question that cannot be currently answered is the impact of loss of the employee voting shares trusts as the corporation enters the post-workout period. Lessons for Stakeholder Use of CCAA Processes Three lessons can usefully be drawn from the Algoma experience with respect to corporate governance and effective restructuring processes. The first is that stakeholder participation must be accompanied by corporate governance change and a business plan that addresses the source of the firm's distress if recognition of multiple interests is to be sustained and meaningful. Second, the structure of debt and equity is a major determinant of whether a viable business plan is possible. Absent bargaining leverage, any gains in governance by equitable investors are at risk if the company experiences further financial distress. Third, the role of government can seriously influence outcomes in an insolvency proceeding. With respect to the first lesson, clearly not all workout situations are appropriate for worker buyouts. Businesses that are not potentially viable should not be restructured. However, without the informational capital and participation of workers and their unions in the exercise of determining whether there is a viable plan, these decisions will not be fully informed decisions. Moreover, insolvency proceedings provide one of the few opportunities for workers to acquire governance change. The discounted value of shares affords workers the only opportunity to purchase equity (through investment or wage deferral) in sufficient quantity that they can influence governance change. Even if a restructuring plan does not require a worker buyout, it often necessitates compromise of workers' claims under collective agreement obligations. Any such workout further increases the risk of workers losing all of their human capital investment. Thus, in being

174 Creditor Rights and the Public Interest

asked to further invest, workers and their unions, just as other creditors, should be able to extract some governance change as part of the bargain. This may involve seat(s) on the board of directors or changes to the way in which decisions are undertaken in the workplace. Traditional creditors, particularly secured creditors, have been very effective in ensuring that any compromises worked out in the plan of arrangement include access to governance change. Usually the board is replaced during restructuring, and senior managers are often replaced unless their expertise is key to the activities of the restructured enterprise. The 1991-2 Algoma workout illustrates that negotiations for restructuring and the commitment of human capital investment can give workers and their unions access to governance structures. While workers were initially given access because of their 1991-2 equity investment (exchange of their fixed claims and reduction of wages for an equity stake), the union was able to shift the focus of governance to one that accounted for workers as equitable investors, having regard to both their human capital and their equity capital investments. Economic performance was enhanced post-workout by directly involving those with the greatest interest in the viability of the corporation in the governance of the enterprise. The 1991-2 restructuring illustrates how a model of corporate governance that recognizes multiple investments and a goal of enterprise wealth maximization can work in the Canadian context. It also opened the door for further conceptualization of governance issues during the important period of negotiations under a CCAA proceeding. In respect of public interest considerations, it may be that the high dependence of this northern community on a single corporation and the lack of easily transferable skills were part of the reason that the court recognized that it had a role in facilitating the workout where snags in the process occurred. In holding that a determination of whether a plan is reasonable must take into consideration the impact of the plan on all interested parties, the court signalled that it would take diverse interests into account in its decision making. Post-1995, the value of workers' investments was diminished with the agreement to issue additional equity capital to meet the five-year capital expenditure plan agreed to in the 1992 CCAA Plan. Some initial steps were taken to address this problem. In 1998, the corporation implemented a mandatory payroll deduction directed towards share purchase, the shares of which continued to be voted by the trust. During recapitalization, governance changes were safeguarded by the

Algoma Steel Corporation: Recognition of Human Capital Investments 175

incorporation of participation guarantees in both the corporate articles and the collective agreement. If the corporate articles no longer entrench these rights, it is doubtful that the collective agreement on its own will be sufficient to sustain this governance over the long term. This is not to suggest that the worker buy-out and governance changes at Algoma were purely transitional arrangements. When given the opportunity to cash out 10 per cent of their shares in 1997, more than two-thirds of the employees chose to retain them. The majority of workers, that is, were committed to share ownership and the resulting governance model. When the corporation began to suffer from low market prices, currency exchange problems, and dumping, under its joint governance structure it made the decision to cut jobs and to create other efficiencies. Steve Boniferro, vice-president of Algoma Steel, observed that a co-determination model of governance helped ensure greater buy-in by all stakeholders when tough economic decisions needed to be made. In 1999, decisions were made to close two facilities, resulting in six to seven hundred fewer jobs. While the financial difficulties placed pressure on the joint process to act more quickly, creating some friction, -the union and managers were able to make the tough decisions jointly. That joint decision-making process ensured that harms to workers from restructuring decisions were minimized and that retraining and relocation were high corporate priorities. By means of retirement incentives, skills upgrading, and shifting workers to new jobs created by the DSPC, the number of actual jobs lost was reduced substantially. Rather than allowing workers' human capital to depreciate, comprehensive skills training accompanied capital investment in new production technologies. From the union's perspective, however, a key lesson is that economic conditions directly affect the union's ability to utilize its governance role to protect workers' human capital investments. Declining markets tempered its governance power. The difficulty is that the model has few precedents as the parties continue to craft strategies for long-term governance. The 2001 CCAA proceeding is a reminder that debt capital claims will always take precedence in insolvency. While debt enforcement is temporarily suspended during the stay period, ultimately, failure to negotiate a plan acceptable to creditors will result in bankruptcy and creditors' entitlement to enforce their claims based on the hierarchy of credit under the BIA. In this context, any retention of governance rights is a positive gain for workers. The structure of equity and debt was clearly more conducive to compromise in 1991 than it was a decade

176 Creditor Rights and the Public Interest

later. In 1991, the creditors had a long-term interest in the corporation, and Dofasco, the major non-bank creditor, wanted to exit. Both factors facilitated a compromise and workout. In contrast, in 2001 the major creditors were distressed debt lenders. As noted in previous chapters, these creditors acquire claims on a severely discounted basis and are interested primarily in the liquidation value of those claims. Thus they have little interest in the upside potential of a workout, and these investors face little downside risk to failed negotiations for a workout, which gives them considerable bargaining leverage. This was problematic for the union, because creditors and the CRO generally concluded that the workers and pensioners bore all the downside risk from the corporation's failure and would agree to any concessions in order to effect a workout.37 This meant that the noteholders were able to gain a greater proportional share of the workout proceeds. The only factor that mitigated this situation was that the capital debt was held by different creditors than the operating debt. The union and the operating lender consortium were able to work together to craft a fallback arrangement whereby the lead bank in the consortium of operating lenders would acquire the company out of bankruptcy. Only then, when the downside risk of a bankruptcy was recognized, were the noteholders willing to bargain.38 Equally important, the union did not register as a creditor in the 2001 CCAA proceeding. Thus it was not a fixed capital claimant. The court was nonetheless willing to have USWA participate because of its long-term interest in the viability of the corporation, and because the court recognized that future negotiations, such as the collective agreement changes, would form part of the compromise and arrangement necessary to a viable business plan. The court's recognition of USWA and the workers as high-value investors was important to successful conclusion of the plan. The court's approach supports the model suggested in this book in terms of promoting the objective of enterprise value maximization, respecting the hierarchy of credit, and recognizing the investments and interests of workers in devising a viable workout plan. The union also faced some pressure from members who had watched their equity holdings rise in value to twenty dollars per share and then plummet again without being able to sell their shares. Thus, there were normative pressures to vest equity ownership in individual workers this time, which may have long-term negative consequences,

Algoma Steel Corporation: Recognition of Human Capital Investments 177

given that many of the governance gains made by workers were due to the voting power of the trusts. No independent directors were appointed to the new board. Since all the governance reports coming out of the TSX and similar exchanges advocate at least some membership of unrelated or independent directors in order to enhance corporate governance, this decision may prove problematic for the corporation. The dominance of noteholder directors may encourage managerial opportunism in the absence of effective monitoring controls. The union directors will thus have a heightened monitoring role, to reduce the risks inherent in governance. While these problems may be transitional in the sense that the need for capital over the long term will likely result in Algoma becoming widely held, in the interim, there is risk of directors extracting a control premium to the disadvantage of minority shareholders and other stakeholders. Given the size of their unaffected debt claims, operating lenders may also serve a monitoring function in this respect. Current pension benefit levels are protected under the plan, a very significant preservation of pensioners' interest. The pension losses would have been devastating to a very vulnerable set of stakeholders and the workout provided a better outcome than liquidation. However, the removal of future inflation increases is a compromise of $124 million for pensioners. The pension promise is for value previously rendered. Recognizing the need for informed consent on compromises accepted under the plan by more vulnerable stakeholders, the court ordered independent legal advice for the pensioners, paid for as a priority administration charge.39 However, the need to protect these claimants was a key concern of the union, which in turn gave other parties, less concerned with a viable workout, enhanced bargaining power during the negotiations. The third issue raised by the Algoma Steel case is the role of government in restructuring proceedings. Often governments quietly assist in restructuring, for example, forgiving various kinds of debt as part of the restructuring strategy. While all creditors must make compromises in the restructuring process, governments must compromise to a greater extent in the sense that they have competing public policy objectives of debt collection and encouraging the survival of businesses. On the one hand, they wish to collect money owing through tax instruments, contributions to CPP, and workers' compensation, as well as industrial start-up or recapitalization loans. On the other hand,

178 Creditor Rights and the Public Interest

closure of operations can have devastating effects for local communities in terms of decreased local tax bases, lost tax revenues from financial difficulties faced by spin-off economic activities, and increased costs of social supports in terms of employment insurance and welfare assistance. Thus governments will often assist the restructuring through debt forgiveness, loan guarantees, or other adjustment measures. In the 1991-2 Algoma workout, the union believes that without the government's intervention, the restructuring would not have occurred. As described above, the Ontario government was willing to use the bargaining leverage at its disposal in support of workers and the community. It used the incentive of over a hundred million dollars in loan guarantees to help bring parties to the bargaining table. It relieved lenders and preferred shareholders from the cost consequences of environmental liability in the event of default and realization of the security, and these environmental waivers facilitated negotiations for restructuring.40 The federal and provincial governments provided funding for employee training and older workers' adjustments. The Ontario government adopted a special securities regulation, which gave protection to directors and officers against personal liability arising out of future operations, and which gave Algoma and Algoma Finance the status of reporting issuers. Use of public resources to facilitate workouts is not only productive in terms of employment creation or maintenance, it also places governments in a position to extract governance change as part of the terms of the workout. Governments are not necessarily the optimal arbiters of whether plans are worthy of support, but they can facilitate recognition of stakeholder interests. In the Algoma Steel 1991-2 restructuring, the Ontario government's support for worker representation on the board of directors and for a co-determination model of governance, combined with the incentives offered by the government, were enough to persuade creditors to consider an alternative model of governance. In the 2001 CCAA proceeding, Ontario's Conservative government adopted a radically different approach. It was ideologically opposed to assisting with the restructuring, and publicly commented that it would neither bail out the company nor assist it in any way. This initial posturing was replaced with a level of cooperation, albeit reluctant, when the government realized that it was liable through the Pension Benefits Guarantee Fund for the pension shortfall of more than $650 million. In the end, the government agreed to guarantee

Algoma Steel Corporation: Recognition of Human Capital Investments 179

what was arguably already their obligation, although the costs of the corporation to litigate this issue at a time of financial distress may have been prohibitive. During the 2001 proceeding, the government never assigned anyone to deal with the environmental issues and liabilities, although these could have been substantial on a wind-up. The federal government likewise did not intervene to assist in a supportive way with workout negotiations. It could have played a role in the governance decisions, in much the same way that the provincial government did in 1991-2. While the federal government agreed to the $50 loan guarantee in order to effect the plan implementation, its failure to engage more in the process meant that vulnerable stakeholders had less bargaining power. This was notwithstanding the fact that the potential losses to the federal government from employment insurance costs and revenue losses were enormous. The absence of government support also resulted in a diminution of the bargaining leverage that the union had utilized in the first CCAA proceeding, in terms of preserving the co-determination gains. One key lesson the union has learned is that government intervention in support of governance rights for workers makes all the difference in the workout process. It creates the space to conceptualize governance structures that recognize all interests in the workout.41 Also of note is that the community did not mobilize during the 2001 workout proceedings to the extent that it had in 1991/2. This represented a conscious decision by community members. Generally, they believed that the corporation was so fragile, it would collapse if its customer base exited out of fear of liquidation. While galvanized community support may have created some strategic advantage in terms of public pressure, the downside risks of creditor and consumer exit were considered too high, given current markets. Another factor was that, unlike in 1991-2, the union had full access to information regarding the sources of financial and economic distress of the corporation, and thus could see where value could be preserved. The community's role in pressuring for information was not as urgent as it had been a decade earlier. On balance, the 2001 Algoma Steel CCAA proceeding is a success. The enormous losses that would have been sustained by the most vulnerable stakeholders had the corporation been liquidated cannot be overemphasized. Pension benefit levels are protected, the workers have retained some job security and governance rights for the near future, senior creditors will continue to have their claims met, trade

180 Creditor Rights and the Public Interest

suppliers have some upside equity potential and valuable contracts continuing, and economic activity for the community is preserved for the time being. Long-term projections are difficult, but as an application of the public interest objectives of the CCA A, the case is an important illustration of the framework's potential.

6 Judicial Recognition of 'Social Stakeholders7 in CCAA Proceedings: Anvil Range Mining Corporation

The Court in its supervisory capacity has a broader mandate. In a receivership such as this one, which works well into the social and economic fabric of a territory, that mandate must encompass having an eye for the social consequences of the receivership too. These interests cannot override the lawful interests of secured creditors ultimately, but they can and must be weighed in the balance as the process works its way through. Mr Justice Blair, 1998'

Recent cases brought under insolvency proceedings indicate that the courts are slowly moving towards a more textured understanding of their role in reorganization proceedings, particularly in discerning the inherent tensions between creditor rights and public interest considerations. Of significance is the courts' recognition of the diverse nature of stakeholder interest in a corporation's financial distress and that such interests give rise to diverse and complex types of claims. Algoma Steel, discussed in the previous chapter, set the stage for the courts' recognition of new types of stakeholders as affected parties in CCAA proceedings. Even where stakeholders do not seek a role as prominent as that of the union in Algoma Steel, the courts are increasingly recognizing their social and economic interests. The Anvil Range case reflects this new concern. Anvil Range Mining Corporation owned and operated a zinc mine called Faro Mine. Its operations directly supported the economies of two local communities in the Yukon and generated 20 per cent of the

182 Creditor Rights and the Public Interest

territory's Gross Domestic Product.2 Thus it was not only a significant local employer but a critical part of the Yukon's economic base as well. Anvil Range experienced financial distress in the late 1990s as the result of intense global competition and low zinc prices in the international zinc market. It applied for protection under the CCAA in 1998. At the time of filing, there was more than $40 million in debt and significant issues with respect to environmental remediation. The significance of the CCAA application of Anvil Range Mining Corporation is that its employees and their union were afforded an active role in the CCAA process, notwithstanding the fact that their fixed capital claims for wages and benefits had been satisfied early in the process. The importance of Anvil Range's operations to the Yukon territorial economy, likely influenced the court's consideration of the interests at risk. In the Anvil Range case the court expressly discussed, for the first time, the interests of 'social stakeholders' in insolvency proceedings. While Anvil Range was ultimately converted to a liquidation process in the context of a CCAA proceeding, the court's findings have important implications for how courts should approach the interests of non-traditional investors. Recognition of stakeholder interest has both a process and a substantive component. The process component is one of ensuring that parties with an interest in the insolvent corporation are afforded the opportunity to participate in the development of a plan. The substantive component involves granting express consideration of the substantive interests of workers and the community. This is a departure from the traditional role of the court, although, as discussed in previous chapters, there is ample judicial support for plans of arrangement that benefit multiple parties and the public interest generally. Curragh Inc/s CCAA Proceeding To appreciate the Anvil Range case, one must look back to the previous owner of the Faro Mine, Curragh Inc., which Anvil had purchased from the receiver in previous CCAA proceedings. Curragh ran a large mining operation, both nationally and internationally. It became insolvent in 1993 and filed for CCAA protection. Although a number of factors contributed to its insolvency, most significant was the company's disastrous management of the Westray Mine in Nova Scotia, in which massive health and safety Violations resulted a mine cave in, and the

Judicial Recognition of 'Social Stakeholders' 183

deaths of twenty-six miners. The Faro Mine was the corporation's principal remaining operation. The Curragh Inc. case represents the first time that a Canadian court granted substantive rights to stakeholders, beyond the value of their fixed capital claims.3 The court granted participation rights and substantive remedies to reflect the interests of a First Nation Council and to the territorial government in a representative capacity on behalf of Yukon miners. Early in the proceeding, the Yukon government, active on behalf of the miners, sought and received a lift of the stay in order to permit the filing, registration, preservation, and commencement of proceedings under the Yukon Miners Lien Act. The court recognized that the territorial government represented the interests of stakeholders within its jurisdiction, even though those individuals were not before the court. This is one of the first instances in which a government acted as agent for vulnerable claimants in representing their interests before the court in a CCAA proceeding. The court lifted the stay and thus granted substantive relief to those claimants. As discussed in chapter 4, while the court will not lightly exercise its discretion to lift a stay during the period of negotiations and workout under a CCAA application, it will do so in order to allow vulnerable claimants to protect their interest. In Curragh, the stay was lifted during the phase of the proceedings in which a restructuring plan had not yet been negotiated, allowing those claimants to preserve and move to enforce their claims. The court in Curragh also recognized the Ross River First Nation as a party, and this was the first time that a First Nation had been recognized as a party in a commercial restructuring proceeding. The Ross River Dena Nation had three kinds of interests. It had relatively minor fixed capital claims owed to its economic development corporation, the Ross River Development Corporation (RRDC). The Ross River Dena Nation was also seeking to enforce First Nations land claims against the corporation, where it was asserting title to Curragh's lands. Finally, as part of the community affected by the social and economic losses from the firm's distress, it had a broader interest in the outcome of the proceedings. The Ross River Dena Nation brought motions both to preserve its land claims and to challenge the court's jurisdiction to bind the First Nation under the CCAA. It also asked the court to require the interim receiver to negotiate a socio-economic development agreement with

184 Creditor Rights and the Public Interest

RRDC that would bind any purchaser of the mine. The court recognized the Ross River Dena Nation as a party to the proceeding. While it declined to hear the Nation's argument regarding land claims, treaty rights, and the right to mine, the court held that it would hear from the Nation as a party affected by the restructuring.4 The court held that the RRDC was an 'affected person' under the CCAA proceeding to the extent that Ross River First Nation members were residents in the immediate vicinity of the Faro Mine. It found that the Nation 'had an undoubted interest in the outcome of the proceedings, both because of the need for ongoing environmental maintenance of the mine site and because the future economic prospects of the RRDC remained contingent on ongoing operation of the Faro Mine.'5 The court's order set a precedent in that it ordered its court-appointed interim receiver to request any proposed purchaser of the Faro Mine to negotiate in good faith a social and economic benefits agreement that was reasonably satisfactory to the Ross River Dena Council. It directed the interim receiver to report back to the court in this respect. The court also held that any participation or consent by the Ross River Dena Council regarding the sale of lands would be without prejudice to their claims regarding the land. Thus, while the First Nation had a comparatively small debt claim, its interests were recognized as much broader than its fixed capital claims. The orders regarding the First Nation and the earlier order regarding the miners' liens represent the first time that a Canadian court granted substantive relief for such stakeholders.6 Curragh established the basis for a further development in the recognition of diverse interests when Anvil Range Mining Corporation, the 1993 purchaser of Faro Mine, experienced serious financial distress six years later. In the CCAA application of Anvil Range Mining Corporation, the Ross River Dena Nation was accorded participation and decision rights in the negotiations for restructuring. Anvil Range Mining Corporation: Concurrent Restructuring and Receivership Proceedings As noted above, depressed zinc markets caused Anvil Range to experience financial distress such that it applied for and received CCAA protection in 1998.7 Secured creditors had opposed extensions of the stay period, arguing that the corporation could not successfully devise a business plan acceptable to creditors. Secured creditors also opposed

Judicial Recognition of 'Social Stakeholders' 185

a continued CCAA process, because the corporation had failed to negotiate with key stakeholders during the initial stay period.8 Other stakeholders included the union representing the mineworkers, United Steelworkers of America ('USWA'); the former mining employees of Anvil Range; residents of the towns of Ross River and Faro; and the Ross River Dena First Nation. Given the importance of the mine's operation to the territorial economy, three levels of government were involved in trying to bring stakeholders together to establish an acceptable restructuring plan. Extensions of the CCAA stay were granted, but it became increasingly clear that the debtor corporation would not be able to successfully negotiate a plan of arrangement or compromise with creditors. The court was faced with the difficult decision of balancing the senior creditors' rights to enforce their claims and the anticipated devastating social and economic impact of the firm's demise. In a somewhat novel approach, the court decided to run parallel receivership and CCAA proceedings. The flexibility of the statutory language means that the court is able to convert applications under the CCAA into receivership proceedings. Here, the court chose to allow simultaneous processes under its supervision. When a number of creditors determined that the company's proposed plan was not feasible, they supported a motion to appoint an interim receiver.9 The court initially adjourned this motion to allow Anvil Range and stakeholders an opportunity to explore whether a last-minute restructuring proposal by the corporation addressed the needs of various stakeholders for an early re-opening of the mine. The union and the Ross River Dena Nation were active participants in these negotiations, as were all three levels of government. Although employees' wages and severance had been paid out, and thus the workers had no fixed capital claims to be satisfied, the court recognized that the workers and their union had an interest in the outcome of any proposed restructuring.10 The Yukon Territorial government stated that its objective was to establish a process that ensured a fair, open, and inclusive process.'11 The parties participated in meetings with the debtor corporation to discuss the feasibility of a plan of arrangement. The Yukon Territorial government tried to facilitate an amended restructuring process, with the objective of ensuring the protection of Faro Mine as an ongoing undertaking. Its efforts were aimed at ensuring that no one interest dominated formulation of a plan, and thus it played a mediating and facilitating role. The Yukon

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government also sought a coordinated, long-term environmental protection plan. The government's view was that stakeholder interests, including those of the mineworkers and First Nations residents, were to be taken into account consistent with other objectives of the restructuring process. By April 1998, the monitor advised the court that the major stakeholders had lost confidence in the corporation's managers, and that continuation of the CCAA process was futile unless an interim CEO was appointed with the support and cooperation of the key stakeholders.12 The Yukon Territorial government, while advocating an early reopening of the mine, also concluded that Anvil Range was hopelessly insolvent and that no real progress had been made in the restructuring effort in the ninety days since the initial stay order.13 Despite spending over a million dollars of stakeholders' money during the stay, the corporation had failed to advance a detailed plan acceptable to creditors, nor had it come up with any proposal that might have allowed the mine to re-open. The Yukon Territorial government advocated a public workout process, rather than one involving private parties, in order to ensure that the public economic and social interests of Yukon residents were met. It therefore supported the appointment of an interim receiver while allowing a parallel continuation of the CCAA process. Given that it served multiple interests to keep open the possibility of a negotiated restructuring, no one objected to these parallel processes. Arguably, there was some question as to whether CCAA and receivership proceedings can co-exist. Here, the parties understood that it was open to any party who wished to fund development of a plan to do so. The court appointed an interim receiver over all property, assets, and undertakings of Anvil Range. Part of the interim receiver's duty was to facilitate a transfer of the Faro Mine to a new operator in a manner that took account of interests of all the stakeholders.14 In the Anvil Range case, this included the Yukon territorial government (YTG), the Ross River Dena Nation, and the union. While the YTG was a creditor, its fixed capital claims were considerably less than those of the principal stakeholders, the YTG representing less than 10 per cent of the aggregate amount of secured claims.15 The YTG made it clear to the court that it continued to represent broader interests, those of residents on environmental and economic development matters.16 Similarly, the fixed claims of outstanding wages had been paid, and the union's role was to represent workers' interest in the long-term viability of the corporation.

Judicial Recognition of 'Social Stakeholders' 187 The Court's Express Recognition of 'Social Stakeholders' In August 1998, in deciding a motion in the Anvil Range case, the court expressly recognized the interests of 'social stakeholders.' This decision recognized that stakeholder interests and resultant participation rights do not have to attach to fixed capital claims. The interim receiver of Anvil Range had filed a report with the court, suggesting that it was unlikely that Faro Mine would re-open in the following two years, possibly even in five years' time. Based on that analysis, the interim receiver recommended to the court the sale of additional assets that it referred to as the 'residual equipment.' This equipment, including mine shovels and drills, were assets without which the mine could not become operational again.17 The interim receiver and the majority of creditors argued that the court should endorse the recommendation, according considerable weight to the views of the court's appointed officer. They argued that the economic reality was that the mine would not re-open in the foreseeable future, and that some of the residual mining assets ought to be sold to satisfy creditors' claims.18 They suggested that if the mine were to open again, the company could purchase new assets. While all the creditors had an interest in the mine being in production, given existing world prices and exchange rates, secured creditors argued it was better to sell the assets on a piece-meal basis to recover some value. Over 90 per cent of the secured creditors supported the asset sale. The court was asked to balance the likelihood of the mine reopening against the need to satisfy creditors' claims, the daily deterioration of equipment, and the costs to the receiver of securing the equipment. The secured creditors argued that they were business people analysing the prospect of a reopening, that the statute was fundamentally a creditor process, and that it was not for the court to inject its views into the process.19 The union argued that the interim receiver did not have expertise with respect to projections of world zinc markets and exchange rates, and that, as a result, the court should not give its usual deference to the report of its officer. The union presented no evidence to the contrary, but argued that the interim receiver was engaged in a highly speculative exercise, and that a further sale of assets had potentially very grave consequences. The union acknowledged that there was only a slim chance of the mine re-opening. However, given the enormous economic impact on the workers and communities, the GDP of the Yukon, and the limited recovery that the sale would effect for the creditors, it submitted that the court should not order the sale. Re-

188 Creditor Rights and the Public Interest

placement of the equipment would be very expensive, essentially guaranteeing that the mine would never re-open. It argued that it would be premature to sell the assets required for long-term production, that the interim receiver needed to develop a new mine plan, and that, absent such a plan, the court should not order the asset sale.20 Similarly, the Yukon territorial government argued that it was not appropriate to require a sale where there was no marketing plan for the enterprise before the court.21 It asked for the motion to be adjourned in order to allow the YTG to conduct further analysis on the underlying assumptions of the interim receiver's report, and on the underlying report on which the recommendation was based. It submitted that the sale was premature and that the price paid would literally be to forfeit the ability of the mine to re-open. The creditors hoped to realize approximately $1.6 million out of a total debt of $40 million, or four cents on the dollar.22 Yet for this limited return, assets essential to the mine's reopening were to be sold. The YTG argued that the resale price for shovels and drills would not differ significantly over the next few years and thus these assets should not be sold, as the sale would adversely affect the prospect of the mine re-opening. It argued that absent a mine plan, any proposed sale was speculative and should be delayed; that the court should have before it a cogent effect analysis on the proposed sale of equipment, as well as the mine plan and better information on projected zinc markets internationally.23 Both the YTG and the union pointed out that the mine would only be profitable during windows of high zinc prices, that the mine had at best three to five years of production left, and that it needed to be able to become productive very quickly, to maximize revenue over a short period of time. The equipment had to be in place to respond to these expected market changes, and its sale would foreclose the opportunity of these last years of production and employment. Further, the government argued that there was no evidence of prejudice to the creditors before the court, if the sale were to be delayed pending development of a mine plan. In a judgment dated 20 August 1998, Mr Justice Blair refused to allow the sale of further assets of Anvil Range at that time. The judgment is significant in that the role allotted to what the court called the 'social stakeholders' was substantive rather than merely procedural. The court recognized that all the secured creditors and virtually all of the creditors supported the sale of the additional assets. It noted that 'those with an "economic" interest in the assets favour their immedi-

Judicial Recognition of 'Social Stakeholders' 189

ate sale/ It found that the union and the YTG were social stakeholders representing workers and the Yukon public, based on a concern about jobs and the general public interest.24 The court equally found that it was difficult to be optimistic about the mine's future prospects and it acknowledged that the social stakeholders had conceded that the chances of the mine reopening in the near future were slim. However, the court also noted that the expert report concluded that the mine's best chance for recovery entailed keeping the mine on stand-by mode to allow it to become operative quickly if market prices increased. To become operational, the mine would require the equipment that was proposed to be sold. The court held that it must always accord great deference and weight to the recommendations of its appointed officer, the receiver. While creditors are entitled to pursue their remedies, that entitlement is not entirely unrestricted, particularly where the secured creditor has sought a court-appointed receiver. However, Mr Justice Blair held that the court in its supervisory capacity has a broader mandate, and that where a receivership works into the social and economic fabric of a territory, that mandate must include consideration of its social consequences. While these stakeholder interests cannot override the lawful interests of secured creditors, they must be weighed in the balance.25 The court then found that the cash which would be generated by the sale was not a large portion of the debt, particularly when the evidence suggested that a material change in the value of the equipment if it were not sold that season was unlikely. The court further held that the interest saving over one year was not 'too great a price to pay to preserve the social and political spirit of those who wish to see the Mine re-open if at all possible.'26 Consequently, the court adjourned the sale motion for several months, allowing the YTG to undertake its analysis. The court's endorsement of the necessity of considering the social and economic consequences of a particular decision represents another step in the evolution of judicial thinking, in which nebulous notions of public interest are being clarified as various stakeholder groups seek participation rights. It also reinforces the earlier observation that social and economic consequences may affect the court's response to both the CCAA process and to options for resolution. Creditors are entitled to pursue their remedies. However, under the CCAA, enforcement may be delayed in the overall balancing of competing interests. Interestingly, neither the YTG nor the union coined the phrase

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'social stakeholders'; rather, it was counsel for one of the creditors who used the term, in seeking to diminish any weight that the court might give to the role of these stakeholders at the hearing. Anvil Range is also significant in that it was the first recognition of social stakeholders and the legitimacy of their interests in undertaking the balancing required in CCAA applications. The judgment supports the notion that the restructuring process should take account of investments beyond quantifiable fixed capital claims. Stakeholders affected by firm failure should be given both participation and decision rights in the negotiation for plans and for decisions that may affect that process. While the outcome of negotiations for restructuring at Anvil Range was unsuccessful, this does not detract from the fundamental notion that these stakeholders have valuable contributions to make in determining whether a viable restructuring plan can be crafted. While the court's acknowledgment of stakeholder interests beyond purely fixed capital claims was an important and timely one, the distinction between economic and social stakeholders may prove problematic. The judgment refers to the creditors as those with an 'economic interest' and the laid-off employees and the Yukon territorial government as 'social stakeholders.' Yet the interests of workers and governments are economic as well as social. In this case, the distinction did not diminish what the court accomplished: recognition of broader stakeholder interests. Yet it could create problems in future cases. By failing to recognize that the interests of workers result from their economic interest in terms of their human capital investments, the court leaves itself open to creditors' arguments that such stakeholders should have seriously reduced participation and decision rights. Having made that observation, the Anvil Range decision nonetheless represents an important evolution in the court's thinking. Use of the term 'social stakeholder' was an attempt by the court to distinguish debt - that is, the fixed capital claims of creditors - from other kinds of interests, such as those of workers, local governments, and communities. As discussed in previous chapters, there is a compelling argument that participation and decision rights should be extended to broader numbers of stakeholders, given the nature of investments they have at risk in the insolvent corporation. The court has subsequently acknowledged the importance of considering the interests of social stakeholders in several CCAA cases. In Skydome Corporation, the court cited the Anvil Range judgment, and in particular, the passage which recognized the court's mandate to con-

Judicial Recognition of 'Social Stakeholders' 191 sider the interests of social as well as economic stakeholders.27 In Enterprise Capital Management, the court adopted the Anvil Range reasoning in respect of considering the social and economic consequences and broader public dimension.28 The Alberta Court of Appeal in Fracmaster similarly held that the spirit of the CCAA contemplates an attempt at restructuring for the general benefit of all stakeholders.29 There the court endorsed the lower court decision refusing to sanction a proposed plan because it was not aimed at the general benefit of stakeholders. In Re Starcom, the British Columbia Supreme Court likewise endorsed the importance of social stakeholder concerns in the CCAA process. The court held that the community protected under CCAA orders is greater than shareholders and creditors and encompasses suppliers, employees, municipalities, and the broader community affected by the well-being of the company.30 The Anvil Range case also illustrates the degree to which parties to insolvency proceedings are concerned about their environmental liability and the courts' willingness to consider the public interest aspect of environmental remediation. This is particularly the case with resource-related industries that pose specific issues of environmental protection. In the Anvil Range case, the parties ensured that environmental protection was being undertaken with funds derived from assets subject to the secured interests of the creditors.31 Environmental protection measures included pumping to prevent outflow of the 'noncompliant water' into a nearby creek and intervention to prevent suspended sediment concentrations from passing through the Sheep Pad Pond in excess of allowable discharge limits. The Yukon territorial government stressed to the court that it had a vital interest, on behalf of Yukon residents, in ensuring that the corporation's insolvency did not interfere with compliance with existing water licences. What was required was a neutral officer of the court to ensure that the company met its environmental protection obligations. The corporation was already in default of requirements of its water licence to file annual reports, and the YTG argued that it could not be entrusted with the responsibility of environmental protection. The court responded by ordering environmental maintenance and coverage of costs of that maintenance.32 The recognition by the court of social and economic stakeholders in Anvil Range and other cases has set the stage for worker and other interests to be seriously considered by secured creditors and the debtor corporation. They now understand that the court will engage in a

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balancing of the interests of and prejudices to such stakeholders when the matter ultimately comes before the court. Since 90 per cent of all matters under CCAA proceedings are resolved through negotiation and settlement, this judicial oversight assists more diverse stakeholders in enlisting the cooperation of parties outside of the courtroom, where the most important discussions for a workout occur. Preserving the Public Interest Anvil Range remained under interim receivership until 2001, and the public interest claimants continued to be involved in ensuring the most beneficial outcome to the proceedings. In 1999, the YTG and the federal government's Department of Indian Affairs and Northern Development (DIAND) had concluded a memorandum of understanding that established a special-purpose trust to ensure that the mine was kept in a state of readiness for production in the event of an increase in world zinc prices.33 The trust also ensured that environmental compliance requirements would be met in the future. Cominco Ltd., a major secured creditor, became site manager, responsible for the development of an environmental reclamation program and mine plan. In exchange, Cominco acquired protection from environmental liability and first option to operate the mine in the event of a change in zinc prices. The trust funds derived from territorial and federal government contributions to cover environmental costs, to be recouped by a levy on the mine's production if it is ever reactivated. Negotiations were held with certain lien claimants to arrange for sale of assets not vital to a start-up, and some of the sale proceeds assisted with the reclamation program and with keeping the mine in a state of production readiness. The federal government and the Ross River Dena Nation explored whether they could enter into a metal recovery process to allow the nation to recover some of the value of its interests.34 These initiatives illustrate the nature of the interests of government and other stakeholders, their willingness to craft mechanisms to protect those interests, and the importance of allowing participation rights to effect such change. In 2001, the court sanctioned a plan of arrangement developed by the interim receiver that was essentially a sale of assets to the government creditors. They would assume responsibility for funding the ongoing necessary environmental maintenance program.35 The plan was supported unanimously by the three secured creditor classes, the min-

Judicial Recognition of 'Social Stakeholders' 193

ing lien claimants, Cominco, and a class comprised of government creditors, DIAND, the YTG and the Yukon Workers' Compensation, Health and Safety Board. The court dismissed unsecured creditors' objections to the plan, finding that there was nothing in the legislation prohibiting an interim receiver from proposing a CCAA plan. It held that there was no value remaining for the unsecured creditors, and they were unaffected by the plan such that the interim receiver was reasonable in not giving them a vote. The court observed that Anvil Range was well below the Plimsoll line in terms of any mining company purchasing the corporation with a view to resuming operations, given the enormous environmental liabilities. The projected amount to be realized on the sale of assets was approximately $15.5 million, to satisfy more than $90 million in secured debt. The court held that the interim receiver is an officer of the court, that it has a duty to be objective and neutral among all parties in the insolvency, and that it had acted in a reasoned and practical manner. The plan was a compromise of claims for creditors who, for the foreseeable future, were the only stakeholders with an 'actual stake' in Anvil Range.36 The court held that it was not unreasonable to sanction a plan directed solely at secured creditors where the debtor's assets were of insufficient value to yield any recovery to unsecured creditors. There was no dispute regarding the secured claims of Cominco or the Miners' Lien Act claims. The court held that although the claims of DIAND, the third secured creditor class, were in part contingent in regard to future reclamation costs, DIAND had already expended $6 million in environmental remediation and was likely to spend the entire amount projected for clean-up by March 2002. Moreover, the amount of secured claims already greatly exceeded the asset value, even without calculating in the future environmental claims. The court also dismissed the argument that the interim receiver should seek contribution for environmental liability from former corporate entities operating the mine, given the cost and the impossibility of recovery. The court found that while the 1999 memorandum of understanding was aimed at preserving future operational capacity, there was no indication in the circumstances that the mine would reopen in the foreseeable future. The court held that approval of the plan allowed creditors to move on with their lives while leaving the mine under proper stewardship.37 The unsecured creditors, Cumberland Asset Management, Global Securities Corporation and others, appealed the judgment, alleging

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that the plan was not fair and reasonable because it eliminated any possible recovery by unsecured creditors and was contrary to the principles and purposes of the CCAA and environmental remediation legislation. In dismissing the appeal, the Ontario Court of Appeal observed that Anvil Range was important to the fabric of the Yukon Territory and that the objective of the CCAA was to enable compromises for the common benefit of creditors.38 The lower court did not err in accepting the interim receiver's assessment of the value of the corporation's assets. The appellate court declined to deal with the more general issue of 'polluter pays' in terms of the priority of environmental claims because at least $16 million had been expended for environmental remediation under court orders for the interim receiver and thus was a valid secured claim. It held that the plan was fair and reasonable in the complex circumstances of the operation of the mine, no hope of the sale generating sufficient funds to satisfy the secured creditors, and no possible recovery by the unsecured creditors. The court held that this plan would provide some closure while allowing the mine to be under proper environmental stewardship. One might be tempted to conclude that the final outcome of Anvil Range was a failed CCAA proceeding. While it is true that the mine will not be operational in the foreseeable future, the CCAA process accomplished some important public interest goals. The recognition of multiple interests allowed the corporation to attempt a viable workout. The 'social' or 'public interest' stakeholders ensured that all options were canvassed. Workers' fixed claims were paid out in a timely manner. Claims under lien legislation realized some value. The key public interest issue, environmental maintenance, has been addressed for the near future. While there are long-term negative social and economic consequences to a sale of assets, the three years under CCAA protection did ensure that best efforts were made to try and find a viable workout. The fact that larger economic factors, such as world zinc prices, did not allow a plan of continued operations does not detract from the importance of the case in developing notions of the public interest. While social stakeholders were recognized, ultimately, as the court observed, those with an 'actual' stake - that is, a secured capital claim - were entitled to finality in the process and to what value could be salvaged.

7 Competing Public Interest Considerations: Canadian Red Cross Society

All insolvency reorganizations involve unfortunate situations, both from personal and monetary perspectives. Many which make their way through the courts have implications beyond simply the resolution of the debt structure between corporate debtor and creditors. They touch the lives of employees. They have an impact on the continued success of others who do business with the debtor company. Occasionally, they affect the fabric of a community itself. None, however, has been characterized by the deep human and indeed, institutional tragedy which has given rise to the restructuring of Canadian Red Cross. Mr Justice Blair, 20001

The Canadian Red Cross Society insolvency was precipitated by more than $8 billion in tort claims by thousands of Canadians ill or dying from contaminated blood products.2 More than 230 actions and 10 class actions involved claimants suffering from Hepatitis C (HCV), HIV, Creutzfeld Jakob disease, or some combination of these illnesses as the result of inadequate testing and screening. As a not-for-profit corporation, the Red Cross had operated a blood donor operation since 1940 and Canada's National Blood System, with funding from the federal and provincial governments, since 1977. Services of the Red Cross included supply of blood and blood products, disaster relief, homemaker services, and international relief and crisis intervention. The Red Cross employed almost ten thousand people at the time of the CCAA filing. Canadian Red Cross Society illustrates the complex

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interests that can be involved in an insolvency workout, as well as the challenge of negotiations where the harms are devastatingly real. In addition to the tort claims filed by the affected individuals (the 'transfusion claimants'), there were also cross-claims and third-party claims from hospitals and governments. The quantum of remedies claimed and the cost of defending hundreds of actions would have resulted in the bankruptcy of the Red Cross. Consequently, the Red Cross sought and obtained insolvency protection pursuant to the CCAA, asking the court for the opportunity to develop a plan of compromise or arrangement. It proposed as part of that process to transfer responsibility for the Canadian blood supply to a new national blood authority. Although early case law was unsettled, judicial pronouncements and statutory amendment have now clarified that the term 'creditor' includes tort claimants as contingent creditors within the meaning of insolvency legislation, if the contingent creditor can establish a provable claim. In the case of the transfusion claimants, in a report arising out of an inquiry into Canada's blood system, Mr Justice Krever had noted that no amount of money would compensate for the pain, suffering, and premature death caused by the blood-related injuries.3 Thus while the claims were of a contingent nature, and the individual claims remained to be determined, the interests of the transfusion claimants had been established before the Red Cross filed under the CCAA. Canadian Red Cross Society represents an important illustration of the necessity and efficacy of the role of the court in ensuring an orderly process where time is of the essence. In this case, a speedy resolution was necessitated by the reduced life expectancy of many of the transfusion claimants. While the objective that parties are afforded fair and reasonable opportunity to assess and make their positions known is highly laudable, logistically, it is extremely difficult to accomplish when there are multiple parties, different levels of sophistication among stakeholders, varying degrees of familiarity with the CCAA process, vastly inequitable resources to participate in the process, and radically different views as to whether the corporation should survive. In the Canadian Red Cross Society case the court was faced with a difficult balancing of interests and prejudices of multiple classes of current and potential future tort claimants affected in different time frames and with different health outcomes. There were numerous trade creditors; employees with pay equity, wage, pension contribution, and benefits claims; more than twenty unions representing employees in different

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provinces; and stakeholders such as the directors of the Red Cross. The agencies that were eventually to purchase the blood-related assets had identified possible outstanding pension liability issues and were concerned that those issues be addressed. The court granted transfusion claimants, unions, employees, and pensioners status to participate in the proceedings. It appointed representative counsel for the transfusion claimants, to be funded by the federal and provincial governments. For the pension litigation, funds for representative counsel came out of monies held in escrow. The order for representative counsel and provision for payment of their fees eliminated a serious barrier to participation for these stakeholder groups. The court's practice of ordering financing for creditors' committees out of the corporation's residual assets had set the precedent for this kind of funding order. Such orders were even more important for transfusion claimants and workers because the cost of participation would otherwise have been prohibitive. In some cases, transfusion claimants had spent several years just trying to find counsel willing to take forward a class action. In many CCAA applications, workers and other stakeholders are unaware of their potential participation and decision rights. Often it is only where the debtor corporation has determined that it is in its interests to involve such stakeholders that an effort is made to seek financial assistance to facilitate this participation. Where the interests of the debtor corporation converge, at least in part, with those interests, representative counsel provides an important means by which non-traditional creditors acquire participation rights. However, such stakeholders should be able to easily seek participation and decision rights on their own initiative. The initial order for a stay pursuant to the CCAA in Canadian Red Cross Society was made on 20 July 1998.4 It specified that the Red Cross was not disqualified from carrying on operations of the national blood system pending its transfer to a new national blood agency. The Red Cross was also permitted to carry on its non-blood activities in a manner consistent with its objectives and past practices, including its disaster relief work and its homemaker services to 80,000 Canadians annually. The Red Cross was further granted permission to pay legal and monitor fees, outstanding and future wages, benefits, pension benefits and other amounts owing to employees, premiums on director and officer liability insurance, and other reasonable expenses to carry on business pending development of the plan of arrangement, and it was ordered to remit to appropriate authorities any statutory

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deemed trust amounts in favour of the Crown.5 Sale of assets was restricted to sales of less than $1 million unless the Red Cross received approval of the court. The court appointed a monitor to assist the Red Cross in the development and implementation of a plan; to monitor its activities; to assist in holding and administering any meetings to vote on the plan; to report to creditors on the financial condition and prospects of the Red Cross; and to report from time to time to the court. The monitor was not to manage the affairs of the corporation. The federal, provincial, and territorial governments (FPT governments), the Red Cross, and two blood agencies, Canadian Blood Services/Societe Canadienne du Sang (CBS) and Hema-Quebec (H-Q) had worked out the terms of sale of assets in a National Blood Program acquisition agreement in which the national blood system would be transferred by the Red Cross to CBS and H-Q.6 The Red Cross would retain its other activities, such as homemaker services and disaster relief. Given that CBS and H-Q had already negotiated the acquisition agreement prior to the CCAA filing, the court ordered that nothing in its initial stay order would restrain or otherwise affect the rights pursuant to the National Blood Program acquisition agreement. The court directed that pending the granting of an order approving the acquisition agreement, the Red Cross and the monitor were to cooperate with CBS and H-Q to assist in resolving transitional issues in contemplation of transfer of the blood system. The order contained the usual come-back clause, specifying that there was nothing to prohibit any interested person from seeking direction of the court on notice. The court order also requested the assistance of any Canadian court or administrative or regulatory body to 'act in aid of and be complementary to this court' in carrying out the order, deeming the monitor to be a foreign representative of the Red Cross pursuant to section 17 of the CCAA. The Red Cross operates both nationally and internationally, and this order was to ensure the effectiveness of the stay order in other Canadian jurisdictions. The challenge of effectively managing complex cases under the CCAA and of according substantive and procedural recognition to diverse stakeholder interests is highlighted by matters that the court was required to deal with in the Red Cross proceedings. While numerous procedural and substantive matters were decided over more than two years, the following three issues illustrate the need to balance the public interest with the claims of various parties to the assets of the corporation: the adjournment sought by the transfusion claimants on

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the motion for approval of the sale of the assets; the court-approved process to resolve pension claims; and the restructuring plan itself. Sale of Assets in Advance of Court Approval of a Plan Adjournment to Allow for Meaningful Participation The court was asked to deal with a motion to sell the assets of the National Blood Program pending development of a proposed plan of arrangement. The proposed sale arose out of governmental and public pressure to ensure the safe delivery of blood and blood products across Canada. A commission of inquiry had previously examined the blood system in Canada. Mr Justice Horace Krever, in the final report of the commission, recommended the immediate development of a new blood system in order to protect public safety and the creation of a no-fault scheme for compensation of blood-related injury.7 The proposed new national blood authority consisted of two agencies: CBS, which provided the national blood program to all of Canada excluding Quebec, and H-Q, which provided blood services to Quebec. The proposal to divest the Red Cross of the National Blood Program was brought to the court for approval. As the result of extensive governmental negotiations and deadlines on a line of credit, the planned sale was scheduled to take place on 1 September 1998. The tight time frame required expeditious court approval of the sale. Yet at the point that the motion for sale of assets came before the court, representative counsel for the transfusion claimants had only recently been appointed. Representative counsel sought an adjournment of the motion to allow these claimants to adequately assess the planned sale of the assets. The court, in deciding whether to delay dealing with the proposed sale and transfer, was required to balance the interests of the creditors, federal, provincial, and territorial governments, and in particular, the public interest in having a continued blood supply. The endorsement illustrates that what is in the public interest in CCAA proceedings is not always apparent. It was clearly in the public interest to 'ensure the seamless continuation of the delivery of safe blood products across Canada' and the preservation of the human capital involved in that delivery.8 However, the court also considered the public and private interest in allowing the transfusion claimants as creditors to be meaningfully involved in the process. The court noted that the continued viability and safety of the blood system was absolutely essential and the failure to proceed created a serious risk of firm

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failure and loss of the service of key employees. On the other hand, to deny the adjournment would result in three classes of transfusion claimants being deprived of a reasonable opportunity to assess whether the asset sale would provide a maximization of returns on the Red Cross's blood-related assets. The court held that the CCAA process and approval of the sale of assets must be seen to be fair and reasonable to the transfusion claimants, whose interests lie at the heart of the process. The court noted that it had responsibility for supervising the proceeding, for considering the complexities of the issue, and for ensuring that its decision was intelligent, informed, and not merely a rubber stamp. Its ultimate assessment on the fairness and reasonableness of a plan of arrangement might be hindered if there was a built-in level of real or perceived unfairness to an important group of participants from the outset of the proceedings. The interests of the transfusion claimants, although a contingent interest with respect to the type and quantum of claims, was nevertheless recognized as a valid interest. The court held that in most cases, a request for adjournment would be granted without hesitation because parties in such proceedings are entitled to a reasonable opportunity to assess and respond to proposed actions, not only in their own interests but to assist the court in arriving at a decision with the benefit of cogent submissions. Here, the court held that the people whose claims from blood contamination injuries resulted in the CCAA application, and for whose benefit the result of the sale process is aimed, were left out of the process until after the CCAA proceedings were commenced.9 It therefore granted an adjournment of two weeks to allow representative counsel a reasonable opportunity to assess the proposed asset sale. The court's decision not only represented a balancing of the interests and prejudices at that stage of the proceeding, it also sent a message to the Red Cross that the process must necessarily involve adequate notice and timely disclosure in order to make the participation of the contingent creditors and other stakeholders meaningful. When the motion for the sale and transfer of the blood supply system to CBS and H-Q came back before the court, some classes of transfusion claimants opposed the sale on the ground that the court had no jurisdiction to order a sale pending the development of a proposed plan. The court found ample authority for its jurisdiction to make the order in its power to impose terms and conditions in the granting of a stay under the CCAA and its inherent jurisdiction to fill gaps in legislation to give effect to the objectives of the CCAA.10 The

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1986-90 Quebec HCV claimants objected to the sale and transfer, proposing a plan of arrangement in which the Red Cross would retain control and operation of the National Blood System for a period of time.11 The proposed plan involved the Red Cross converting to a system of direct cost recovery from hospitals, thus generating revenue from a fee-for-service system and enhancing the pool of money available to satisfy the tort claims. The claimants asked the court to dismiss the request for approval of the sale, requesting instead an order directing a meeting of creditors for the purpose of voting on their proposed plan. The court decided to approve the sale of assets because it found the proposed plan of arrangement unworkable, contrary to the current political exigencies, and prejudicial to the blood system, employees, hospitals, and other health care providers. While the court refused to exercise its discretion to order a meeting of creditors to consider and vote on the proposed plan, it clearly acknowledged the right of contingent creditors to propose their own plan of arrangement.12 Thus stakeholders beyond traditional creditors can, within the current statutory language, propose their own restructuring plans under the CCAA. More broadly based recognition of this entitlement would encourage other stakeholders to seek participation rights where they can contribute to the development of a viable plan of arrangement. In undertaking the balancing of interests and prejudices on the sale motion, the court examined expert evidence, the assumptions underlying the proposals, and the positions of key stakeholders such as the federal, provincial, and territorial governments, employees, health care providers, and the transfusion claimants. The court concluded that the value that would be recovered with the sale, $169 million, was close to the maximum likely to be obtained. After the debt to the bank was paid and claims of other creditors defrayed, there would still be 70100 million dollars in a trust fund to satisfy transfusion claims.13 The court gave full consideration to whether the sale was fair and reasonable in all the circumstances. Its decision to allow the timely sale of assets also meant that the informational capital and skills of workers were not lost to blood services, because the new blood agencies hired virtually all of the 3,230 employees from the transfusion part of Red Cross' operations on the same terms and conditions of employment. Thus the court engaged in a balancing of the interests at risk and considered the prejudice to all stakeholders affected by the decision. This reasoning was subsequently adopted by the Alberta court in Fracmaster, where the court held that the objective of the CCAA to

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facilitate restructuring should include consideration of interests beyond those of senior creditors.14 Effective Use of Mediation/Arbitration to Settle the Pension Claims In a number of recent CCAA cases, an important issue has been determination of claims to and distribution of pension fund surpluses. For most pension plans, the benefit is based on an estimate of future earnings and payout experience. Where the assets earn more than predicted or (more rarely) the pay-out costs are less than predicted, a surplus results. The Supreme Court of Canada has held that an employer can take a contribution 'holiday' where there is a pension plan surplus if the language of the plan permits, and if the actuary concludes that the contributions are not required.15 A pension trust is irrevocable and the surplus belongs to the beneficiaries, unless the trust specifically allocates the surplus to the employer or where there is a sufficiently broad power of amendment in the trust documents to permit the employer to amend the trust document to revoke that part of the trust that is surplus. It is usually ambiguity in the language of the trust document combined with differing provincial legislation governing the process for obtaining the surplus that results in uncertainty of ownership and claims to the surplus. When a corporation reaches insolvency, these issues come to the fore, since the pension surplus may be viewed by creditors as a possible source of funds to satisfy claims. In Red Cross, development of a plan was not possible without first ascertaining what amount of money might be available to satisfy the claims of various stakeholders, including workers and pension beneficiaries, in terms of the pension surplus. The acquisition agreement that transferred the national blood supply included provision for a protocol to settle outstanding pension claims. After its execution, the Red Cross would give notification to all unions representing employees or beneficiaries of Red Cross' pension plan, and notice to all nonunionized employees and interested individuals. Red Cross and the new blood agencies were then to enter into discussions with unions and others regarding disclosure of potential pension claims and design a process to resolve them within sixty days. The issues involved potential liability of the Red Cross and CBS and H-Q in relation to potential pension claims; disposition of the debtor corporation's pension plan assets and liabilities; transfer of pension plan assets; and/or

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establishment of new pension plans by the new blood agencies or the Red Cross. The acquisition agreement included an order for a holdback of $32 million to be placed in escrow pending resolution of the pension liability issues.16 The sale and transfer of assets closed in September 1998 and $32 million of the proceeds went into escrow; the parties subsequently negotiated and received court approval for a procedure to resolve the pension liability issues.17 The procedure involved broad notice through a variety of means, and a mediation process with the Honourable Lloyd Houlden, a retired justice of the Ontario Court of Appeal.18 The stakeholders agreed to make their best efforts to settle outstanding disputes. Parties were to resolve whether the Red Cross was entitled to pay administrative expenses from the pension fund; whether liability for pensions had transferred to the new blood agencies in plan obligations; and the amount of money to be used from the escrow fund to satisfy pension claims. Failing successful mediation, the parties agreed to litigate the matter before an arbitrator, who would interpret the relevant collective agreements and legislation across Canada. The procedure was aimed at full and final resolution of the pension issues, in lieu of any civil action or process before any statutory pension regulatory agency. Any mediated or arbitrated resolution also required approval of the court. The protocol provided for funding for representative counsel out of the amount in escrow. Twenty unions, as well as the non-union employees and former employees, were represented by four representative counsel in the mediation/arbitration process. The Red Cross pension plan was registered in Ontario but subject to the statutory requirements of provincial pension legislation across Canada. Thus, the court concluded that this procedure could not bind the parties in respect of their right to argue that minimum statutory standards had not been met in these jurisdictions. Given the number and complexity of claims involving many jurisdictions, the process was practical, cost effective, and timely. Numerous pensioners were dependent on expeditious resolution of the issues. Mediation was conducted over three days and final approval negotiated over several months. The settlement meant that these claims no longer had to be negotiated as part of the CCAA plan. The procedure followed was significant not only in terms of the CCAA process, but in implementing an alternative method of dispute resolution in the context of rights litigation. The employment of repre-

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sentative counsel experienced in both pension and labour matters redressed the imbalance in power between the corporation and the pension beneficiaries while enhancing access to the process and saving considerable court resources. The court's retention of jurisdiction to approve any resolution created safeguards in the mediated outcome, as did its determination that substantive rights under the applicable pension statutes were preserved. In this context, mediation was highly successful. The court also approved one of the representative counsel of the transfusion claimants to represent their interests in the pension-related mediation. The aim was to ensure that transfusion claimants were kept advised on the process. The involvement of the transfusion claimants in the pension dispute resolution process was novel, because these tort claimants had no direct claim in the pension dispute and would normally not be involved in resolution of such claims. Practically speaking, however, approval of a plan of arrangement would not be possible without support of these creditors, because their claims exceeded the value of the assets of the corporation. Moreover, the plan's development was contingent on resolving the pension liability issues because this would determine the pool of assets available for a workout. The need to ensure the fairness of the process before it reaches the court for final sanctioning was met by allowing the participation of transfusion claimants in the pension dispute resolution process. The parties used dispute resolution techniques as alternatives to litigation in other parts of the CCAA proceeding as well. For example, there was a $47 million pay equity claim by the Service Employees International Union (SEIU). The Red Cross had been required to negotiate a pay equity plan pursuant to pay equity legislation, and had previously set aside $15 million in trust transferred from the provincial government to satisfy pay equity claims.19 When it was subsequently financially distressed, it hired a consultant to revise the pay equity plan, with the Red Cross taking the position that it owed considerably less than $47 million in pay equity adjustments. During the workout proceedings, the Red Cross and the SEIU negotiated a settlement of the claims in the amount of $10.2 million in lump-sum payment to workers covered by the pay equity plan. A motion to approve the settlement was stayed, however, until the court was satisfied that the transfusion claimants had the opportunity to assess the money in trust and the amount of claims settlement.20

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There are two interesting observations to be made about the process to resolve the pay equity claims. First, the claims represented a sizable portion of the unsecured claims in the proceedings and the Red Cross needed to devise a means by which the amounts owing could be resolved. The use of negotiations as an alternative to litigation was crucial in resolving the claims amount and in allowing the Red Cross to move the CCAA proceedings forward. The settlement of the claims allowed workers to receive pay equity adjustments while ensuring that the Red Cross met its obligations under the Pay Equity Act. Se ond, because the claims were unsecured, the court endorsed having an SEIU representative on the trade creditors' committee. Although membership on the creditors' committee carried with it certain confidentiality requirements, the union was able to better monitor the corporation's activities during the workout process, and to make more informed decisions on behalf of its members in respect of the restructuring plan.21 Equally important was the informal exchange of ideas that such participation allowed. Given that the negotiation of a plan in CCAA proceedings occurs primarily outside of the courtroom, exposure to other creditors and the ability to exchange views helps traditional creditors to better understand the claims of workers and other stakeholders, including their willingness to compromise and to help devise workable plans of arrangement. The successful incorporation of workers on the creditors' committee of the Red Cross is an example of one type of the participation rights advocated earlier in this book. The Red Cross Plan of Arrangement

The Red Cross obtained several extensions of the CCAA stay period from 1998 to 2000, in part because the federal, provincial, and territorial governments had entered into negotiations with the 1986-90 HCV claimants regarding compensation. In considering whether to exercise its discretion to extend the stay, the court expressly recognized that negotiations between the governments and the transfusion claimants would have a significant impact on the formulation of the plan.22 The court also granted longer stay periods, aimed at avoiding the necessity and cost of the Red Cross having to return to the court for extension of shorter stay periods. This flexibility, coupled with firm case management, ensured that the CCAA proceedings worked to promote an optimal outcome in restructuring negotiations.

206 Creditor Rights and the Public Interest

In balancing the interests and prejudices involved during formulation of the plan, the court also lifted the stay to allow fifteen transfusion-related lawsuits to proceed.23 The court held that there were compelling reasons that these proceedings be allowed to proceed, chief among which was the reduced life expectancy of some of the claimants. The court dismissed another motion, however, in which former management employees sought a lift of the stay to determine a related-employer issue, finding there was nothing to take these particular claimants out of the CCAA claims process.24 The stay was aimed at giving the Red Cross a 'respite from litigation/ The court's determination of these motions illustrates the way in which the court engages notions of public interest by examining the specific prejudice to parties in any given decision. Where the stay might cause creditors irreparable harm, as for those transfusion claimants whose lives were at risk, the court lifted the stay. However, public interest concerns such as general employment standards legislation would not necessarily override the public interest in an effective, timely, and streamlined determination of a plan of arrangement under the CCAA. In May 1999, the court approved a series of actions: a request to convene meetings with Red Cross creditors to consider and approve a plan; an order establishing a claims procedure for the transfusion claimants; setting a claims submission date; and extensive notice arrangements.25 The monitor was directed to provide to each person claiming an information package with instructions on how to complete and submit the forms. It prepared a list of transfusion claimants for the sole purpose of determining eligibility to vote on the proposed plan. Seven thousand copies of the plan and related materials were mailed. The monitor was initially to review claims and ask the claims officer to resolve any dispute. The Red Cross then conducted meetings with creditors in 2000 to consider, and, if advisable, pass a resolution to approve the plan. The CCAA plan of arrangement refers to a settlement between the federal, provincial, and territorial (FPT) governments and claimants in the 1986-90 class actions. Successful negotiation of the CCAA plan was dependent on this settlement, which would eliminate claims that the Red Cross had to meet and thus increase the pool of assets available to satisfy those which remained. Under the FPT settlement agreement, the FPT governments would pay $1.5 billion to approximately 10,000 persons infected, directly or indirectly, with the Hepatitis C virus as the result of blood or blood products received from 1 January

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1986 to 1 July 1990.26 The agreement provided full and final settlement of all 1986-90 class actions and individual actions, crafting a payment scheme that recognizes both severity of illness and current and future negative health effects. Thus, rather than provide the transfusion claimants with a one-time cash settlement, the agreement is tailored to pay compensation as each person's circumstances evolve in the future.27 A number of the traditional onuses of proof in civil proceedings have been reversed in the claims adjudication process under the settlement, thereby hopefully reducing the transaction costs in claims processing. A court-appointed independent administrator manages the fund. Protocols were negotiated by the administrator and a joint committee of four class action representative counsel for a claims process, including notification and testing, initial claims determination by the administrator, use of an ombudsperson to mediate disputes, and a mediation and arbitration procedure for appeal of claims. If the claims are for less than $10,000, the claimant must appeal through the mediation/arbitration procedure. If the disputed claim is $10,000 or greater, the claimant has the option of utilizing the referee procedure under the Rules of Civil Procedure, in which the referee makes a report to the court and the claimant has all the normal rights of appeal. A claims centre has been set up in Ottawa, Ontario.28 The joint committee continues to give advice and direction and undertake some monitoring, not unlike a creditors' committee in a CCA A proceeding, although general oversight will be the responsibility of the court. The joint committee has authority to approve matters on a unanimous basis, and failing unanimity on major issues, the administrator will seek advice and approval from the court. The fund will be reviewed every three years to ensure that it is being properly administered. The FPT settlement agreement for the 1986-90 transfusion claimants was approved by the courts in the Ontario, British Columbia, and Quebec class-action proceedings, where they determined that the settlement was fair, reasonable, and in the best interests of class members. The courts held that settlement produced the best possible result, and that the provision for payment by degree of harm with progressive increases with worsening health was an overriding advantage for class members.29 Payments began in 2001, and adjudication of complaints will continue into 2003. The settlement represents the largest personal injury settlement in Canadian history. As noted above, the plan of arrangement under the CCAA proceedings had been dependent on the successful approval of the FPT settle-

208 Creditor Rights and the Public Interest

ment agreement. The settlement allowed funds from the transfer of the Canadian Blood Supply, to be made available under the CCAA plan to transfusion claimants infected pre-1986 and post-1990 who were not eligible for compensation under the FPT settlement agreement. The 1986-90 transfusion claimants were deemed to have assigned the benefit of their rights and interests to the FPT governments, who then had the right to vote for the proposed plan of arrangement. The plan of arrangement provided ordinary creditors with claims of $10,000 or less with 100 per cent of their claim, and claims greater than $10,000 with 67 per cent of their proven claim. The plan established a trust fund for the transfusion claimants of $79 million plus accrued interest, specifying the following terms: $600,000 for Creutzfeld Jakob disease claimants; $1 million for class-action claimants alleging infection with Hepatitis C from blood obtained from U.S. prisons; $500,000 for transfusion claims not otherwise provided for; $63 million for claimants in class actions alleging Hepatitis C pre-1986 and post-1990; and $13.7 million for settlement of HIV claims.30 The funds were to come from both sale proceeds of the blood assets and negotiated contributions from co-defendants in various actions and insurers. The plan establishes procedures for claimants to apply to referees, the Honourable R.E. Holland and the Honourable Peter Cory, for determination of the amount of their damages, and the courts in each province were asked to give recognition and assistance to the sanction order and to implementation of the plan. The plan also authorized the Red Cross to make payment in accordance with a settlement with the Service Employees' International Union with respect to a collective agreement and other issues involving homemaker employees. Thus, under both the settlement of the class actions and the plan, money was set aside in trust. However, claims were to be individually refereed or mediated, and if those processes failed to settle the claim, arbitrated based on exposure and harm. Unlike some of the trust arrangements in the United States, claimants can seek increased compensation as new harms are manifested. Voting on the CCAA plan involved two classes of voting creditors. The first class was comprised of all ordinary creditors other than the transfusion claimants, with voting based on the dollar value of their claim. The second class included all the transfusion claimants, who for purposes of voting on the proposed plan were given one vote per person, that is, a value of one dollar per claim as opposed to a vote attached to the alleged value of their tort claims.31 This voting structure was directly modelled on that used in U.S. mass tort proceedings.

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The transfusion claimants would have claims only against the trust, and the trust assumed full responsibility for resolving the transfusion claims and administering the costs of doing so. The plan specified that rights were preserved except against the Red Cross, present and former officers, governors, and employees. The assignment of one dollar per transfusion claimant for the limited purposes of voting on the proposed plan was a novel means of granting the transfusion claimants voting rights on the proposed plan without first having to spend considerable resources to quantify the value of their claims. There are precedents for this approach in U.S. tort cases, although none had actually dealt with the court's jurisdiction to employ it. The U.S. experience indicated that the valuation of claims is a very costly exercise and ultimately depletes the value of assets available to satisfy claims. Valuation can also create untimely delays, a factor to be considered when the tort claimants are already very ill or dying. Thus it made more sense to accept the Red Cross proposal for purposes of voting on the proposed plan, since it did not affect the value of claims that could be asserted either in the plan's claims process or in civil proceedings if they were to continue. On 30 August 2000 all classes of creditors, including the classes of transfusion claimants, voted overwhelmingly in support of the plan. Ordinary creditors voted over 99 per cent in number and value in favour of the plan. The FPT governments that cast their own vote, as well as assigned votes of the 1986-90 transfusion claimants under the government settlement, voted 100 per cent in favour. Of the remaining transfusion claimants, 91 per cent in number and value of votes cast were in favour of the plan.32 The court sanctioned the plan of arrangement in September 2000. The court observed that many of the transfusion claimants have died and thousands are suffering, and that nothing the court could do would remedy these harms. Measured against this background, the court noted that the CCAA regime must seem inadequate to many. However, the process provided a mechanism 'whereby some order, some closure and some measure of compensatory relief was given, while at the same time offering to the Red Cross the possibility of continuing to supply humanitarian services.33 The court observed that negotiations both under the CCAA and the hundreds of tort cases had been intense and lengthy, involving multiple court appearances. In approving the plan, the court held that it was fair to all affected by it and reasonable in the circumstances. The court held that no plan is perfect, but that the court should approve a plan if it is 'inherently

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fair, inherently reasonable and inherently equitable.' Here, the plan 'balanced the various competing interests in an equitable fashion.'34 The court considered three letters opposing the plan in the context of the thousands of claimants voting in favour. It held that while the court had read these poignant letters carefully, it was satisfied that the issues had been raised and debated in the special meetings held to discuss the plan. The court held that the huge majority of transfusion claimants had supported the plan as the best possible outcome for them in the circumstances. Although the transfusion claimants were not the type of business creditors normally affected by a CCAA plan, the court held that they were the ones most touched by the events leading up to the proceedings, and that their voting support of the plan should be accorded equal if not more deference to that normally granted to creditors by the court. The high level of support, the fact that they were advised by representative counsel, and the changes made as a result of negotiations among all interested parties were all factors for the court. The court also held that it was significant that the Red Cross would be allowed to carry on its humanitarian activities, that it continued to employ 7,000 Canadians in aspects of its work and to make valuable contributions. While the court acknowledged that the bitterness of the claimants was understandable given the harms they had experienced, in the balancing of interests, the continuation of Red Cross' non-blood related activities was important.35 The CCAA plan was dependent on approval of the settlement by the courts seized with the class actions in Ontario, Quebec, and British Columbia, because it resolved those claims against the Red Cross and other defendants. The Ontario court initially denied the motion to approve the settlement, holding that there was insufficient evidence of the contribution of pharmaceutical companies, doctors, hospitals, and insurers named as defendants to allow the court to assess whether releases should be granted. The court held that this information was also necessary to enable class members to determine whether or not to exercise their right to opt out of the class proceedings. The court also concluded that the proposal paid nothing to the 'derivative claimants,' the family members and relatives of infected persons, and was aimed at extinguishing their rights if they failed to opt out.36 The Ontario court subsequently approved the settlement when the requisite evidence was led and the settlement was adjusted to allow for compensation for the derivative claimants.37 The court held that the reasonableness inquiry under a CCAA plan differs from that under

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a class proceeding settlement. The former requires a balancing of interests with a view to carrying on business with the least harm to creditors, employees, and the community.38 For class proceedings, the court must be satisfied that the proposed settlement is fair, reasonable, and in the best interests of those affected by it, and in its determination, the court must be concerned with the interests of the class as a whole rather than those of individual members. The court will consider the risks and costs of trial, the likelihood of recovery in the action, the amount of discovery evidence, the terms of the settlement, the experience and recommendation of counsel, any independent assessment of the settlement, likely duration of trial, the presence of good faith, and the absence of collusion.39 The court determined that the settlement was fair, reasonable, and in the best interests of the class as a whole. The British Columbia Supreme Court had stayed its decision pending resolution of the Ontario court's concern, and it ultimately approved the settlement on the same criteria.40 It also endorsed settlement of claims against the British Columbia government in the amount of $6.5 million for the pre-1986/post-July 1990 class action, to be administered by the CCAA plan trust administrator. The B.C. court held that the high risk of loss at trial, the fact that class members were dying and in immediate need of financial assistance, and the risk of loss of the settlement were all factors in its approval, and that the settlement was in the best interests of the class as a whole. The Quebec Superior Court approved the settlement under the CCAA plan on the same reasoning.41 Lessons for Stakeholder Participation The Red Cross case was the first in Canada to involve tort claimants as key creditors in the CCAA process. The case highlights that the nature of claims and the ability of the corporation to work out its affairs may depend on whether creditors, including non-traditional creditors, have an interest in the turnaround of the financial health of the corporation. For tort claimants, the liability of the corporation arises from its past actions. Given the serious nature of the harm incurred, such claimants are unlikely to be interested in the corporation's survival. Thus, absent some incentive to vote in favour of a plan of arrangement, such as receipt of damages over the liquidation value of their claims, tort claimants are unlikely to support a plan. Generally, contingent creditors

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will support a plan if some compromise of their claims today provides greater realization on their future claims. However, for health-related claims, time may be of the essence. Where there is the possibility of third-party payment of the claims, as in Red Cross, the CCAA process can be used as bargaining leverage for extracting a better settlement. While this is vitally important for the contingent creditors, it can place at risk the negotiations for a viable restructuring plan for the debtor corporation. In Red Cross, most of the health harms had already manifested themselves. Generally, however, in using the trust fund vehicle to satisfy mass tort claims, there may be a problem with ex ante determination of the amount of trust funds required to be set aside for the future satisfaction of claims, when no one really knows the full manifestation of harms that may arise. As the U.S. experience illustrates (see chapter 9), there may be a further question as to the constitutionality of the courts being able to bind future tort claimants who have been exposed to the past actions of the corporation, but the harms have not yet manifested themselves.42 Essentially, binding future tort claimants, without either due process or relative certainty with respect to the amount of money that needs to be vested in the trust to cover their claims, can work to disenfranchise those claimants. Moreover, in Red Cross, three levels of government were implicated by virtue of the public/private nature of the national blood system. This involvement provided a means for the tort claimants to seek damages from pockets much deeper than those of the insolvent Red Cross. In order for corporations to seek the protection of the CCAA, they must be insolvent. Hence, by definition, sufficient assets do not remain in the corporation to satisfy all claims. In contrast, in the United States, corporations do not need to be insolvent to file a Chapter 11 proceeding. The implications of this for the mass tort situation require further study. The corporation exits Chapter 11 with a clean slate in terms of the tort claims, as the trust is considered full satisfaction of those claims. Yet there is some question as to why tort claimants should not have access to a proportional share of the upside value generated from the future economic activities of the corporation, particularly given that the existing residual assets of the corporation have not been used to satisfy these claims. Corporate managers may also have ex ante incentives to engage in more risky product decisions if they understand that the mass tort liability arising from harmful products can be minimized through a Chapter 11 proceeding. Canada has not yet

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had to confront these questions, but they are important considerations in any future use of the trust model in CCAA applications. Workers with pay equity and pension claims in Red Cross had both fixed claims and a strong interest in the future survival of the corporation; thus their interests diverged from those of the contingent creditors. Similarly, trade creditors had interest in both past and future activities of the corporation. As the law is currently constructed, these parties all have the same rights to vote on a proposed plan. In negotiating a workout under the CCAA, the debtor corporation must account for all of these interests to garner sufficient support to have the plan endorsed. The second issue raised by Red Cross is the importance of early disclosure, which allows the parties to assess their positions and, where possible, to mediate a resolution. In Red Cross, the creation of a central data room aided the representative counsel by reducing information asymmetries and controlling the transaction costs inherent in trying to acquire information individually. In turn, this facilitated their participation in the proceedings. Similarly, the ad hoc committee of the transfusion claimants' counsel allowed for a sharing of information and a division of tasks early in the process, as well as providing counsel with a forum in which to attempt to reach consensus on a number of issues. In addition to direct mailing and newspaper ads, extensive use was made of electronic communications and a website that allowed broad and up-to-date access to information for the tort claimants and other stakeholders. Moreover, the support of insolvency counsel allowed the representative counsel to coordinate the various legal proceedings between the courts seized with the tort actions and the CCAA proceedings. This eliminated some of the transaction costs for both the corporation and the tort claimants, by avoiding unnecessary return to the court to amend orders rendered out of date by other proceedings. When the fees of representative counsel for the transfusion claimants were hotly disputed, these efficiencies, in addition to the risks of litigation, were factors considered by the court in approving payment of $52 million.43 However, the Red Cross case also illustrates some of the ongoing problems of information asymmetries highlighted in earlier chapters. For example, the union representing the pay equity claimants only discovered by accident that $15 million had been set aside in trust for settlement of pay equity claims. Although the corporation had disclosed this fact to the court in one of many boxes of documents, it did

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not advise the union of the existence of the trust, not withstanding its $47 million dollar claim.44 Given the volume of information involved in such cases, the question of how much and in what form a debtor corporation is required to disclose its assets to stakeholders remains to be determined. The objective is to find the balance of disclosure sufficient to allow parties to formulate informed positions while controlling the costs of providing that information. Third, the Red Cross case illustrates the importance of good insolvency counsel who are able to craft creative strategies to deal with complex and novel situations. The Red Cross devised a number of negotiation, mediation, and arbitration strategies to resolve as many outstanding disputes as possible prior to seeking approval of its proposed plan of arrangement. It involved multiple interests at various stages of the proceeding to minimize the issues that would come before the court. It creatively utilized the flexibility of the process to ensure that the CCAA proceedings moved in tandem with the class actions and other proceedings to control transaction costs as much as possible. The court's understanding of the importance of this coordination and its flexibility in terms of decisions regarding the lifting of stays, extension of stays, and sorting out the relationships between the parties, was key to success. In Red Cross, numerous 'public interests' were balanced successfully, giving full recognition to the equity, debt, and equitable investments of stakeholders. Competing Public Interests Finally, it is important to observe that where the model worked well in terms of a CCAA plan of arrangement, other public interests may not necessarily have been fully met. There continues to be a live issue as to whether the tort claimants have received social and economic justice. Many of these issues are beyond the scope of a discussion of stakeholders under the CCAA, yet they raise important public interest questions. In respect of the FPT 1986-90 compensation plans, only in late 2002 was a holdback of five thousand dollars per claim released to claimants. While initially created to ensure a minimum level of benefits to all claimants out of the trust, in releasing the holdback the courts found that there is currently an average claims rejection rate of 22 per cent, and thus the payouts have been lower than originally anticipated.45 In total, one hundred million dollars was paid out of the

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1986-90 trust fund to 1,700 claimants in 2001. This can be compared with sixty-two million dollars in fund start-up and administration costs in the same period, with an additional anticipated nine million dollars in such costs to be incurred in 2002.46 Thus in 2001, approximately 40 per cent of all moneys paid by the trust went to professional and administration fees. By 6 February 2002, total compensation payments had risen to $198 million dollars. Part of the 2001 expenses include over a million dollars in legal fees paid to private law firms, in part to appear and oppose claims at claims arbitration hearings.47 However, claimants are not generally entitled to legal representation paid from the compensation plan (partial coverage is available to some complainants by court order). This appears to have been a serious oversight in the design of the plan's compensation procedure as the high rejection rate may reflect claimants' lack of understanding of legal procedures and the evidence required to advance a claim. One wonders whether a law firm or legal clinic with specialized expertise ought to have been designated to represent claimants. The absence of effective arrangements for legal representation is highlighted by the twin requirements of corroborating evidence of transfusion and the exclusion of such corroboration from family members. The courts have granted generous limitation periods and broad definition of family members available to make claims by ruling that Ontario law applies to claims.48 However, another judgment found that the discoverability rule (that a cause of action does not arise for purposes of a statutory limitation until all of the material facts on which it is based have been discovered by or ought reasonably to have been discovered by the plaintiff), could not take precedence over specified statutory limitation periods that run from death under the Trustee Act.49 Moreover, the court held that there were limited funds in the trust fund available for the families claiming and that there was nothing in the framework of the CCAA plan that allowed the referee to consider special circumstances to extend the limitation period. The court held that the trustee does not have any power under the plan to alleviate the effect of its provisions through the exercise of an inherent equitable jurisdiction. These circumstances illustrate the fact that decisions made in the context of a CCAA plan may not fully protect the interests of tort claimants, where part of the plan is to compromise or restrict claims so that the corporation can continue to operate. The competing nature

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of these public interest concerns continues to raise pressing questions both for access to justice and compensation for social and economic harms.

8 Canadian Airlines Corporation and the Public Interest

The court is assisted in the exercise of its discretion by the purpose of the CCAA: to facilitate the reorganization of a debtor company for the benefit of the company, its creditors, shareholders, employees and in many instances, a broader constituency of affected persons. Parliament has recognized that reorganization, if commercially feasible, is in most cases preferable, economically and socially, to liquidation. Madame Justice Paperny, 2000'

The airline industry in Canada has been in a state of crisis in the past two years. Bankruptcy and liquidation proceedings such as that of Canada 3000 have left creditors with debts that are difficult to realize on and resulted in thousands of job losses and consumers scrambling for alternative means of travel. In 2000, Canadian Airlines Corporation, one of Canada's two largest national airline corporations, filed for CCAA protection. The Alberta Court of Queen's Bench ultimately endorsed a survival plan for Canadian Airlines that involved a merger with Air Canada. Driving part of the workout were notions of the public interest and it is this aspect of Canadian Airlines which is analysed in this chapter. The court also dealt with issues such as set off, missed claims dates, the valuing of particular assets, the effect of the plan on letters of credit, and ancillary proceedings under the U.S. Bankruptcy Code. These issues are not addressed here, but were significant substantive decisions under the CCAA.2

218 Creditor Rights and the Public Interest Canadian Airlines' Insolvency and Workout Canadian Airlines Corporation and Canadian Airlines International Ltd. (CAIL) (collectively referred to as 'Canadian Airlines') had successfully implemented restructuring plans in 1994 and 1996 based on private workouts. By 1999, Canadian Airlines was again experiencing financial distress. The source was a high debt load and an eroded capital base that could not withstand fluctuations in revenue and traffic; the high fixed costs of running an airline; and sensitivity to change in the mix of business and budget customers. After a decade of restructuring attempts, it had become evident that the domestic market was not big enough to sustain two mainstream network carriers.3 Moreover, the usual restructuring tools of downsizing unprofitable operations, deferring capital expenditures, and longer trade terms were not possible in the airline industry because of the need for high standards of service and maintenance and the inability to cut operating costs because it would accelerate the rate of decline.4 Other airline carriers did not have the capacity to pick up the thousands of passengers who would be stranded if Canadian Airlines ceased operations, and the federal government consequently invoked emergency powers under the Canada Transportation Act to relax anti-competition rules to facilitate a restructuring of the airline.5 With the corporation's most recent financial distress, early discussions with Air Canada for a merger stalled. Offers to purchase both Canadian Airlines and Air Canada by Onex Corporation were withdrawn following a Quebec Superior Court ruling that the offer violated provisions of the Air Canada Public Participation Act.6 Canadian Airlines desperately required an injection of cash and Air Canada supplied financing in exchange for route access and security on the few unencumbered assets remaining. Although this allowed Canadian Airlines to operate through its busy Christmas season, by January 2000, Canadian Airlines was losing $2 million per day. A corporation partly owned and financed by Air Canada (853350 Alberta Ltd) acquired 82 per cent of the common shares of Canadian Airlines in 1999 after resolution of specified claims, Competition Bureau approval, and federal government clarification of a proposed regulatory framework for the domestic airline industry.7 In a series of transactions, including 853350 Alberta Ltd's acquisition of the preferred shares of CAIL, Air Canada infused capital into Canadian Airlines and assisted in debt restructuring. Early in 2000, Canadian Air-

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lines announced a moratorium on payments to lessors and lenders. The objective was eventual merger with Air Canada after a comprehensive debt restructuring. While negotiations with creditors such as aircraft lessors and conditional vendors resulted in a number of compromise agreements, the failure of Canadian Airlines to reach agreement with creditors holding $175 U.S. million in senior secured notes necessitated a CCAA application in March 2000, with companion proceedings authorized to be commenced in the United States.8 This application would have been filed in any event in order to achieve compromise with the other affected creditors. During the stay period, Canadian Airlines negotiated restructuring arrangements in respect of aircraft to be retained for future operations, and these agreements were approved by the court in April and May 2000.9 Canadian Airlines filed its proposed plan of compromise and arrangement under the CCAA proceedings. That plan was subsequently amended and ultimately involved $3 billion in restructured debt. The stakes in the Canadian Airlines case were high. A failed restructuring would have resulted in 16,000 job losses, many communities losing air service for an extended period, and multiple unknown ripple effects in the Canadian economy.10 Regulatory consents were obtained from the Competition Bureau and the federal government, based on the imminent insolvency and on certain undertakings given with respect to job preservation, preservation of services to small communities, and a process for the divestiture of Canadian Airlines' regional airline subsidiary. The Canadian Airlines Restructuring Plan The CCAA plan of arrangement had three principal aims: to provide short-term liquidity to sustain operations; to allow for return of aircraft not required by Canadian Airlines; and to permanently adjust the structure and lease facilities to reflect market value in return for Air Canada providing guarantees on obligations.11 Some creditor groups were unaffected by the proposed plan, specifically, Canadian Airlines' employees, customers, suppliers of goods and services, Canadian Plus pointholders, and the Royal Bank. After the takeover by 853350 Alberta Ltd was completed, Canadian Airlines devised a restructuring plan with the assistance of Air Canada. The corporation negotiated with key aircraft lessors. Operating lease rates were reduced to fair market value rates in exchange for all lease

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obligations being assumed or guaranteed by Air Canada. Where aircraft were subject to conditional sale agreements, the value of the secured debt was reduced to fair market value, interest payable was reduced, and the claims were assigned to Air Canada.12 The key aircraft financiers negotiated compromises, but they were not 'affected creditors' in the CCAA plan because Air Canada had assumed the liability and the risk of Canadian Airlines' failure. Air Canada in turn sublet the aircraft back on new lower terms to Canadian Airlines, effective immediately. These arrangements meant that the revenue streams of creditors that had been stayed under the moratorium were restored. When Canadian Airlines filed under the CCAA in March 2000 in Alberta, 90 per cent of the aircraft leases had agreed to similar workout terms in letters of intent. The court approved these letters of intent as compromise of values that were reasonable. Canadian Airlines had received the benefit of immediate lower lease rates and the potential for successful restructuring was considerably enhanced. Should the workout ultimately fail, the aircraft were in Air Canada's hands such that they would be placed back into active use with minimal disruption to the public.13 The motion to approve these letters of intent was opposed by Resurgence Asset Management LLC, acting on behalf of a group of unsecured noteholders, and by four shareholders of Canadian Airlines. Resurgence had acquired 60 per cent of the public unsecured debt claims and was opposed to the claim voting rights that Air Canada had acquired on these transactions. It argued that approval would prevent creditors from having a meaningful vote on the plan of arrangement, that the fleet was removed from any access by the trustee if the corporation were liquidated, and that Air Canada should not have the right to vote such a material number of claims as a 'related party.' However, the Alberta Court of Queen's Bench approved the letters of intent, finding that there were considerable benefits to the debtor corporation and its stakeholders. It reserved on the issue of classification and voting rights attaching to the claims. Resurgence sought a stay of the judgment pending a leave to appeal application; the stay application was dismissed by the Alberta Court of Appeal, but the leave motion was never brought. Affected secured creditors under the plan were the senior noteholders with claims of $175 U.S. million, secured by diverse assets. Affected secured creditors received 98.6 per cent total recovery on claims while affected unsecured creditors received fourteen cents on the dollar, in-

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eluding unsecured senior noteholders, claims in respect of outstanding litigation, claims from termination or repudiation of particular contracts, claims of tax authorities, and claims in respect of undersecured or unsecured amounts claimed by secured noteholders. The Alberta Court of Queen's Bench authorized a class placing all the affected unsecured creditors, including Air Canada, into one class. The plan of arrangement and compromise proposed a share capital reorganization. The plan was supported by 100 per cent of the affected secured creditors in number and value, and 65 per cent in number and 76 per cent in value by the affected unsecured creditors.14 The restructuring issues included harmonization of incompatible computer systems, complex collective agreement obligations, complicated crew scheduling challenges, integration and maintenance of routes, and preservation of customer goodwill. Canadian Airlines brought a pre-packaged plan to the court in order to expedite the CCAA process, to minimize loss of its customer base, and to assist with retention of skilled employees. While there were $800 million in claims, the need for a quick proceeding and preservation of relationships considered essential to operation meant that particular claims were not compromised, such as most employee claims, claims of several thousand trade suppliers, advanced ticket sales, executory contracts such as leases, and long-term supply contracts. All of these claims would be paid in the ordinary course of business. Had the corporation failed, most of them would not have been paid, other than preferred claims under the BIA and specific lien rights. Liquidation would also have meant an estimated additional $1.1 billion in unsecured claims.15 Contingent claims were likewise unaffected because of the need for an expeditious workout; however, this meant there was unknown potential liability that was not subject to any compromise. Sean Dunphy has observed that while the pre-packaged plan offered an expeditious and less costly workout, it also made the debtor corporation and the takeover bidder vulnerable to hold-out minorities.16 This became evident in disputes over class, share structure, and terms of the plan. Classification of Creditors In CCAA applications, the debtor usually structures classes of creditors to enhance the possibility of successful endorsement of the plan, as discussed in chapter 4. In Canadian Airlines, Air Canada's claims

222 Creditor Rights and the Public Interest

were placed in a class with other unsecured creditors, thus enhancing prospects for that class to vote in favour of the plan in the required amounts specified by the statute. Resurgence, representing unsecured noteholders and four minority shareholders, opposed the decision to allow Air Canada to vote its assigned claims in the class with all unsecured creditors. The court allowed Air Canada to vote the claims in advance of determination of the issue in order to expedite the process and ordered segregation of the votes until the classification issue was determined. The court then decided the classification issue at the plan sanctioning hearing. The court held that it must consider the statutory objective of facilitating the reorganization of insolvent corporations at every stage of the proceeding. The determination of class was fact driven, and the court would apply the following principles: commonality of interest should be viewed on the basis of preventing excessive fragmentation and interests within a class need not be identical; interests are to be determined by the legal rights of the creditor in relation to the debtor, before and under the plan and in the event of liquidation; and commonality of interest should be given a purposive interpretation having regard to the restructuring objectives of the CCAA. Specifically, the court should resist classification approaches that potentially jeopardize viable plans.17 The court also held that absent bad faith, the motivations of creditors in voting for or against a plan were not relevant, and that creditors should be able to consult together in order to assess their entitlements as creditors. Here, the court held that there was nothing inappropriate in Air Canada shifting the deal risk by voting the claims, that the class had not been devised in bad faith, and that Air Canada as funder of the plan could support it through voting. The court held that the good faith of Resurgence must also be considered, that it had purchased almost all its claims after failure of the Onex bid as highly distressed debt. Resurgence had acknowledged that it did so both for the investment potential and in order to obtain a veto position in any plan not favourable to it. It had advised Canadian Airlines that it intended to use the litigation process to secure benefits, which resulted in Canadian Airlines not negotiating further with it. The court found there was no injustice to treatment of its claims under the same class. In this respect, the court held that injustice must be assessed with respect to stakeholders as a whole.18

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223

An issue also arose in respect of the vote of beneficial owners of unsecured notes. The court held that it had jurisdiction to determine who should be considered for purposes of the 'head count' requirements under the CCAA and that considerations included the terms of the instrument or debenture, the effect of the provisions on a meaningful voice for creditors balanced against the difficulty in determining true beneficial ownership, the terms of the plan, and the objectives and spirit of the CCAA. The court found that in this instance, only the registered holder of the security was entitled to vote, but those beneficial holders could seek to become registered and thus have their voice heard.19 As discussed in chapter 4, there is a practice of crafting classes favourable to the debtor. However, the court in Canadian Airlines made clear that it would apply the list of criteria in order to assess disputes regarding class. It was also clear that this assessment involved broader stakeholder interests in determining the classification complaint of particular creditors. While it has been suggested that the weight accorded by the court to legal interests' could encourage parties to acquire claims and then use the process to effect a purchase of assets, it is more likely that the court's application of these principles would act to prevent such purely opportunistic behaviour. By linking classification principles to the restructuring objectives of the statute, the court is tempering application of the legal interest test and allowing for determination of class beyond narrow legal and commercial interests. While not determinative, this consideration is one of three key principles to be applied. In the application for leave to appeal on the sanctioning decision, the Alberta Court of Appeal also considered the classification issue. It held that Resurgence would have had an effective veto over the plan had Air Canada been removed from the class, and that the lower court had not erred in determining class. The Court of Appeal also held that the judge had not erred in deferring the class issues to the fairness hearing. This outcome makes sense in the circumstances of Canadian Airlines and given the deference of appellate courts in CCAA proceedings. However, generally, delay of classification decisions to the plan sanctioning hearing is not helpful to stakeholders. The time and resources already expended by the insolvent corporation will militate against the court setting aside the debtor's definition of classes for purposes of voting on a plan.

224 Creditor Rights and the Public Interest Oppression Claims and the 'Fairness' Inquiry

Resurgence and a dissenting shareholder brought a motion to lift the CCAA stay to pursue oppression claims against the officers of Canadian Airlines and Air Canada. They alleged that the officers had stripped Canadian Airlines of valuable assets such as flight routes, lease arrangements, and goodwill in a manner that was oppressive; that the nature of the takeover transaction had contained material misrepresentations in terms of returning Canadian Airlines to a viable operation; and that their actions made a post-takeover stand-alone corporation impossible. The shareholder also alleged that the use of the Alberta Business Corporations Act was oppressive in the manner in which it allowed conversion and retraction of all common shares at a value of one dollar, thus eliminating minority shareholder interest in the restructured corporation, and in allowing the preferred shares held by 853350 Alberta to be converted to common shares. Instead of granting the motion to lift the stay, the court ordered the oppression allegations to be heard in the context of the fairness inquiry at the plan sanctioning hearing. The court held that 'oppression is the antithesis of fairness' and thus it was appropriate to consider the issue in the context of the proposed plan, specifically, whether the corporation's actions were 'unauthorized matters' or unfair. The court clarified its jurisdiction to deal with oppression applications under corporations statutes in the context of a CCAA proceeding. It held that the rights and expectations of creditors and shareholders in respect of oppression remedies must be viewed through the lens of insolvency. Equity and fairness are measured or considered in the context of the rights, interests, or reasonable expectations of the complainants. Here, rights were eliminated in the context of an insolvency workout, not because of oppressive conduct. The court held that the breach of the debenture terms did not impact differently on Resurgence than on other defaults under the moratorium. The court further held that pre-filing negotiations were to be encouraged as facilitating the objectives of the CCAA, and as such were not oppressive. The negotiations and arrangements preCCAA filing had prevented bankruptcy and created the stability to facilitate the workout.20 In respect of the oppression claims under the proposed share reorganization, the court held that the Alberta Business Corporations Act allows corporate articles, including share structure and rights, to be

Canadian Airlines Corporation and the Public Interest 225

amended in the context of a CCAA plan.21 It held that the conduct of Air Canada could only be oppressive if there was either a goingconcern alternative under which there was shareholder and creditor value in excess of that anticipated by the proposed plan, or if a liquidation would have allowed recovery for unsecured creditors and shareholders. The court considered a liquidation analysis prepared by the monitor, which estimated that liquidation would result in a shortfall to secured creditors, realization of one to three cents on the dollar for unsecured creditors, and no recovery by shareholders. There were no known alternative going-concern purchasers after more than a year of the corporation searching. Thus the court rejected the oppression claims. It also approved the capital reorganization. The court held that the plan was for the benefit of unsecured creditors. It did not harm shareholders because their economic interest in the corporation had vanished before the CCAA proceedings. Dunphy has observed that in requiring the parties to deal with the oppression allegations in a timely manner through the fairness inquiry, the court removed bargaining leverage that Resurgence had sought in bringing forward the oppression application.22 The fairness hearing lasted ten days and involved viva voce evidence and final argument, with Resurgence and the minority shareholders opposing the plan. The hearing included the participation of the federal government, unions representing the employees, and diverse creditors. The Alberta court approved the restructuring plan, finding that the plan was fair and reasonable and that, while not perfect, it was neither illegal nor oppressive. The court held that the plan was the only alternative to bankruptcy after a decade of struggle and failed creative attempts at restructuring, and that liquidation would have meant losses for employees, customers, travel agents, and others whose claims were not affected by the plan. Resurgence also argued that the monitor had overlooked value in its liquidation analysis. Canadian Airlines had seven registered pension plans and there was some evidence that two of the plans might have $40 million in surplus. The monitor did not attribute any value to pension plan surplus in the liquidation analysis because there were indications that there was a cumulative net deficit position for the seven registered plans after consideration of contingent liabilities; there was a possibility, based on previous splitting out of the plans from a single plan in 1988, that the plans could be consolidated for financial purposes, which would leave no surplus value; the calculations by

226 Creditor Rights and the Public Interest

actuaries indicated that the liabilities were greater; and the monitor did not have a legal opinion that the surpluses belonged to the debtor corporation. The court held that Canadian Airlines had taken advantage to the full extent permitted of contribution holidays and there was no basis established for any surplus available from an ongoing pension plan. The court found that the unions disputed the calculations in terms of liabilities and surplus value available for distribution, that there were additional costs associated with pension plan termination, and that changes in market value of securities held all led to the conclusion that the monitor had been reasonable in assigning a zero value to any pension surplus. Resurgence appealed the order sanctioning the plan of arrangement and compromise. The Alberta Court of Appeal dismissed the application, finding that the court's jurisdiction was limited to either upholding the plan or setting it aside.23 The Court of Appeal held that after the plan was approved, creditors had taken no steps to stay its implementation. By the time that the leave application was filed, the plan had been substantially implemented and a number of irreversible changes had occurred. Thus, setting aside the plan was a remedy no longer available, and since Resurgence had not requested a remedy that was possible, the appeal was considered moot. Moreover, the Court of Appeal held that even if it were not moot, Resurgence had not established any error in law or palpable and overriding errors in fact, and thus had not established prima facie meritorious grounds. The Court of Appeal held that the role of the supervising judge in ensuring a timely and orderly resolution of workout issues, as well as the effect on the interests of all parties, were factors to be considered in CCAA proceedings. It endorsed the lower court's reasoning that oppression must be assessed in the context of the insolvency and reasonable expectations of creditors. Lessons for Judicial Consideration of the Public Interest The Alberta court in Canadian Airlines held that in sanctioning a plan, weight should be accorded to strong creditor support, but that a number of additional factors had to be considered, including the public interest. Madame Justice Paperny held that the objective of the CCAA 'widens the lens' to balance a broader range of interests that includes creditors, shareholders, the company, employees, and the public, and

Canadian Airlines Corporation and the Public Interest 227

that an assessment of fairness must include reference of the plan's impact on all of these constituents.24 The court held that it could not limit its assessment of fairness to those directly affected by the plan. This reasoning is significant, given the large number of interests implicated and the proportionately small number of creditors with affected claims under the plan. Canadian Airlines was concerned about loss of employees during the critical plan implementation period. The restricted number of affected creditors meant there was some risk that particular creditors could extract premiums in the workout. The vast majority of creditors affected by the restructuring, the employees and trade creditors, were high-value creditors with the greatest interest in a viable workout plan and the greatest potential losses in a liquidation. However, given the time pressures on the pre-packaged plan approach, their claims were not compromised and thus they did not have a vote in the CCA A proceedings. The court expressly recognized these broader interests, including the risk to the public of 'chaos to the Canadian transportation system.' It held that companies are more than just assets and liabilities, even in insolvency, and that the fate of the corporation is tied to those who depend on it in various ways. The court also acknowledged that while the 16,000 employees did not have claims affected by the plan, the job dignity and job security protections negotiated for the benefit of workers should not be jeopardized by liquidation, citing the strong support of the plan by the unions representing the pilots, machinists, office workers, auto workers, and airline workers. The court also took note of the ripple effects in the economy if the corporation were to cease operations, including airport authority losses, consumer losses, and loss of accessible air transportation to smaller Canadian communities. The court held that the plan represented a solid chance for continued existence, preserving the business, maintaining 16,000 jobs, keeping trade creditors and suppliers whole, protecting consumers, and preserving the integrity of the national transportation system. Of importance to the notions advanced in this book is the fact that the court expressly recognized that the unions and employees had played a key role over the past fifteen years in working with the corporation and responsible governments to ensure that Canadian Airlines survived, including wage and other concessions as well as governance initiatives.25 This recognition is highly significant in that this was recognition of interests and investments beyond current quantifi-

228 Creditor Rights and the Public Interest

able fixed capital claims. The court held that it is required to consider these larger interests and to assess the impact of the plan as a whole; fairness and reasonableness are not abstract terms, but must be measured against the available commercial alternatives. This is also directly responsive to critiques that public interest considerations will take precedence. Here, the court had evidence of the economic costs and consequences of alternative outcomes. It assessed the viability of the plan, and balanced the available alternatives, considering their impact on diverse parties with an interest in the corporation. This is not to suggest that if senior secured creditors had voted against the plan, that public interest concerns would have prevailed. The failure to garner creditor support for the plan in number and value as required by the statute would have led to the plan's defeat and hence a different outcome. The court made this clear in its observations regarding the weight to be accorded creditors' votes. However, in the exercise of its supervisory capacity, the courts will have regard to the objectives of the CCAA, including consideration of the interests of creditors and the public interest at each stage of the process.

9 International Comparisons: Creditor Rights and the Public Interest

The effectiveness of a workout regime is measured by the extent to which it meets its public policy goals. In France, that goal is a concern about the viability of the enterprise, the economic security of workers and the claims of creditors. It is also a goal of timely action to address the firm's financial distress. Maitre Plartchard, Tribunal de Commerce, France, 2000 [translated from French]

Most industrialized countries have implemented schemes for the liquidation or reorganization of businesses in financial crisis. Depending on whether the particular jurisdiction has adopted a primarily debt collection model or rehabilitation model, the regime accords different responsibilities and obligations to traditional creditors, debtor corporations, workers, other stakeholders, and the courts and their officers. This chapter analyses the public interest theme across four comparative regimes: the United States, France, Germany, and the United Kingdom. To this point, the discussion has focused on how the policy objectives of enterprise wealth maximization and recognition of debt, equity capital, human capital, and other investments should be recognized in Canadian insolvency law. Reference has been made to the need for other policy instruments, such as a national wage protection scheme. While discussion of these instruments is beyond the scope of this book, such schemes may be an optimal way to protect human

230 Creditor Rights and the Public Interest

capital investments - although it is less clear how they could be crafted to protect other components of the public interest. The ideas presented in this book are only part of the equation where protecting the diverse investments of stakeholders is concerned, just as corporate restructuring is part of a much larger scheme of priorities and enforcement of credit. In the same vein, we must be cautious about drawing definitive conclusions regarding comparative restructuring schemes, since a particular jurisdiction may have adopted other, more effective instruments for protecting human capital and other investments. While Canada's restructuring regime offers an optimal model for incorporating stakeholder interests, other jurisdictions have been more effective in creating labour adjustment, wage protection and retraining schemes, and broader social safety nets to redress adjustment harms. There are two reasons for including a comparative chapter in the present study. The first is that while the regimes discussed here are not closely converging in their primary policy objectives or instruments, all have recognized the need to provide an alternative to liquidation in order to preserve going-concern value, where appropriate. All of these regimes have attempted to grapple with notions of the public interest and how the interests of diverse stakeholders can be recognized in the process. Each jurisdiction has attempted to strike a balance between public interest concerns and the importance of an effective system of credit enforcement, that balance situating itself depending on the primary policy objective of rehabilitation or debt collection. Second, international comparisons are difficult because of the different legal, political, and economic systems that have shaped the evolution of insolvency regimes. There is a tendency to conclude that if no lessons are immediately discernible, consideration of these differences adds nothing to the debate regarding effective restructuring strategies. Nothing could be further from the truth. Knowledge of other jurisdictions enhances understanding of our own regime; it can also reinforce intuitive conclusions about particular policy instruments such as restructuring. This chapter briefly explores the way in which the four jurisdictions selected have attempted to reconcile traditional creditors' claims to the value of the insolvent corporation's assets with recognition of the public interest of preserving going-concern value, jobs, and the economic life of communities. The choice of regimes discussed is necessarily somewhat arbitrary, but represents a selective comparison of two rehabilitation and two debt collection regimes. Discussion has been con-

International Comparisons 231

fined to jurisdictions with a developed insolvency scheme, to best draw from their collective experience. The United States was selected for comparative purposes because of its similar economic structure and because of the importance of crossborder insolvency proceedings in Canada and the United States. It is illustrative of the difficulties that arise in protecting creditors' rights when the primary policy objective is rehabilitation, almost to the exclusion of other goals. While France's principal policy objective is rehabilitation, the regime expressly embraces the idea of enterprise wealth maximization and its policy instrument of early preventive intervention serves to protect and enhance stakeholder investments. The other two comparative jurisdictions, the United Kingdom and Germany, were selected because their debt collection regimes serve as alternative models of insolvency law. Canada's early bankruptcy laws were modelled on U.K. legislation. The schemes then diverged, with Canada shifting towards certain elements of rehabilitation. While these regimes retain debt collection as their primary policy objective, they have also recognized the need to develop viable restructuring schemes to promote going-concern solutions where it preserves value for creditors and other stakeholders. The instrument through which this objective is accomplished varies. The regimes are briefly described in the context of the ideas set out in this book; as a consequence, the descriptions of the regimes are far from comprehensive and the reader is well advised to consult the many comparative studies undertaken by insolvency scholars.1 While these regimes have endorsed the value of workout schemes, their objectives differ considerably depending on the importance given to debt collection or rehabilitation. The chapter explores how the regimes have converged or diverged in maximizing enterprise wealth, enhancing stakeholder participation, and reconciling the rights of traditional creditors with other stakeholder interests. Comparatively, Canada's restructuring regime offers the greatest potential for an effective regime, because of its multiple insolvency law objectives and its approach to balancing traditional creditor rights with the complex interests involved in consideration of the public interest. Public Policy Objective of Workouts Internationally, the value of mechanisms to allow corporations to restructure is increasingly recognized in public policy, although the re-

232 Creditor Rights and the Public Interesresttt

gimes vary considerably in their underlying debt collection or rehabilitation objectives. In creditor-oriented jurisdictions such as Germany and the United Kingdom, efforts to facilitate restructuring are fairly recent initiatives and have been implemented to address problems of premature liquidation and resultant loss of value accruing to claims. In contrast, rehabilitation regimes, such as the United States, have faced severe criticism for failing to adequately respect the pre-insolvency rights of traditional creditors. Rehabilitation and Chapter 11 of the U.S. Bankruptcy Code Chapter 11 of the United States Bankruptcy Code provides a mechanism for solvent or insolvent corporations to seek court protection pending acceptance of a plan of reorganization. In the United States, the term 'bankruptcy' refers to both insolvency and bankruptcy. The objective of rehabilitation is reflected in numerous statutory provisions. The debtor corporation has a period of 120 days in which it retains the exclusive right to propose a reorganization plan, then an additional 60 days to have the plan accepted by creditors (the 'exclusivity period').2 The U.S. courts frequently extend this period of exclusivity to years, thus allowing the debtor corporation greater control over the proceedings. The United States differs from the Canadian regime in that creditors' rights are stayed for prolonged periods without the debtor having to be accountable to creditors and without creditors being able to propose plans themselves. Under Chapter 11, when a party files a petition, an automatic stay is imposed on both secured and unsecured creditors. The business continues to operate under the notional concept of debtor-in-possession (DIP), where the debtor corporation's directors are controlling a new legal entity, the estate. Thus managers are able to retain control for at least a limited period of time, although they are frequently replaced during or after the Chapter 11 proceeding. Creditors can ask the court to lift the stay for purposes of enforcement of their security if they can establish that it is necessary for the protection of their interests, although courts will not interfere lightly with the exclusivity period. Under Chapter 11 proceedings, the debtor corporation has the right to reject unfavourable contracts and to assume valuable ones; accrual of interest on unsecured liability is suspended; there are express rules for the granting of debtor-in-possession financing; and 'cram down' is available as a means to obtain approval of plans over the objections of dissenting creditors.3

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233

As a consequence, under the U.S. scheme, the debtor corporation has significant bargaining power and can stay creditors' interests for long periods while it devises a strategy to rehabilitate itself. The difficulty with Chapter 11 is that the scheme can be used to defer liquidation, to the considerable compromise of creditors' interests. Very few publicly traded corporations use Chapter 11, approximately 150 of many thousands filing for bankruptcy.4 The U.S. courts have held that the purpose of Chapter 11 is to provide a period of time in which the debtor corporation can attempt to negotiate a reorganization plan acceptable to creditors, but unlike the structure in Canada, creditors have few rights to insist on an expeditious resolution of the proceedings. There has been a long-standing recognition in the United States of the public interest in encouraging corporations to stay in business. David Skeel observes that the history of U.S. bankruptcy law reflects the rise of organized creditor groups, the influence of populism and the rise of the welfare state during the New Deal era, and a politically active bankruptcy bar and judiciary that promoted a rehabilitation model as essential to economic growth in a market-based economy,5 Skeel, drawing on social choice theory, suggests that the development of U.S. bankruptcy law further reflects the cyclical preferences of politicians in various periods of economic wealth or downturn and the consequent concentrated lobbying of creditors or the influence of populist ideology. Railway companies were the first large corporations to fail in the United States, and although privately owned, they were viewed as a public good because of the dependence on rail transportation at the turn of the last century. Given the complex mix of equity and debt, including bonds secured only on sections of track, bankruptcy meant that creditors were unable to realize on their claims. A new device was thus created under common law, the 'equity receivership/ where the court appointed a receiver to preserve value and effect a business reorganization. This formed the basis of modern U.S. reorganization law. Historically, the public interest was protected because the statutory scheme allowed the Securities and Exchange Commission (SEC) to supervise reorganizations.6 Early in its history, the SEC was active in reorganization proceedings as part of its securities mandate to investigate equity receiverships. With the first codification of reorganization proceedings, the SEC was entitled to receive notice of all steps taken, to formulate plans of its own, to inquire into private plans, and to accept the submissions of unions on issues affecting the interests of

234 Creditor Rights and the Public Interest

employees. As early as the 1940s, it was accepted in the United States that the interests of shareholders, workers, consumers, and the general public were to be taken into account in reorganization proceedings.7 The 1978 Bankruptcy Code substantially reduced the role and influence of the SEC; now, it will intervene only on request of the court. The SEC's role was perceived to have evolved to protect equity investors to the considerable detriment of trade creditors and workers, and its investigations were considered time consuming and untimely, and thus no longer appropriate.8 Moreover, with the rise of private industry, there was a shift in concern regarding the need to protect the public interest. However, some of these notions of public interest continue, particularly in more recent failures in the health care, transportation, and utilities industries, which, in the United States, are essentially private businesses but considered important to the availability of a public good.9 Chapter 11 reorganizations are viewed as having a primary objective of rehabilitation, based on concern for the interests of shareholders, unsecured creditors, employees, and the community in which the firm is operating. As in Canada, those interests have largely been defined by the corporation itself, rather than by the stakeholders. Shareholder rights continue unless there is intent to jeopardize the reorganization. The Bankruptcy Code makes no express reference to corporate governance, and scholars have argued that shareholder rights to determine governance matters during insolvency should not be abrogated in the absence of clear statutory directive.10 However, the fiction of the 'DIP' under Chapter 11 means that directors become fiduciaries of the estate rather than the shareholders, creating a conflict. Directors are still elected by shareholders but are now accountable to creditors and shareholders. Legal scholars have criticized the extent to which the scheme protects the debtor corporation, often to the detriment of creditors' interests and ultimately resulting in untimely liquidation of the corporation. The length of the stay period, including the availability of numerous extensions, often results in corporations seeking Chapter 11 protection to prolong the corporation's business life without there being any real possibility of the debtor corporation rehabilitating itself.11 Chapter 11 cases take from two to seven years and create a period of unaccountability, because creditors cannot propose a reorganization plan during the exclusivity period. The U.S. regime has also been criticized for the growing phenomenon of multiple proceedings in which the same corporation returns

International Comparisons 235

repeatedly to protection of the bankruptcy court. Other scholars, however, point to the many cases in which Chapter 11 has successfully been utilized to assist corporations in a turnaround of their financial affairs, resulting in the preservation of employment and local economic activity.12 Skeel observes that the increased use of Chapter 11 mirrors the leveraged buy-out era of the 1980s. He suggests that this was a reciprocal influence. Excessive leveraging in order to pay for these takeovers resulted in a large increase in the number of firm failures and consequent Chapter 11 applications. Equally, the pro-debtor nature of Chapter 11 encouraged takeover activity. Managers had reorganization as an option if there were negative consequences to their decisions on the amount of leveraging to effect a takeover, or on the amount of debt assumed by the target company to prevent the takeover.13 Unlike the restructuring provisions of the BIA and the CCAA, a corporation does not have to be insolvent to file for Chapter 11 protection. Corporations are encouraged to file and restructure their affairs before they become hopelessly insolvent and therefore unlikely to reorganize successfully.14 As with Canada's regime, the U.S. restructuring scheme provides for a process of disclosure, negotiation, voting by class for a proposed plan, and sometimes, appointment of a creditors' committee. Failure to devise a reorganization plan acceptable to creditors in required amounts of support will lead to bankruptcy and eventual liquidation on a going-concern or asset basis. The court, in sanctioning the plan, must ensure that it meets the statutory requirements, including the requisite amount of creditor support. The Code imposes an Absolute Priority Rule (APR) in which senior creditors, unless they agree to compromise their claims, must receive the full value of their claims in cash or equity before the claims of any junior creditors or interests are satisfied under the reorganization plan.15 The counterbalance to this are the so-called cram-down provisions. The court may approve a proposed plan over the objection of dissenting creditors, even key creditors, where it is satisfied that any creditor who has not accepted the plan will receive at least the amount it would have received on liquidation. The cram-down provisions require that the plan must provide for fair and equitable treatment for any dissenting creditor class and not discriminate unfairly with respect to treatment of those claims. While the cram-down provisions promote rehabilitation, they require the court to engage in costly and time-consuming valuation proceedings before approving a plan. Under the cram-down rule,

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shareholders, as the most junior claimants, do not receive any value in the reorganized corporation unless creditors consent or all claims are paid in full. The only exception is where current owners contribute new value in terms of additional equity or credit, in which case they can retain the equivalent of that value without creditor consent.16 The policy objective of rehabilitation, combined with use of the instruments described above, can result in excessive delay in satisfying creditors' claims under the U.S. regime, often without value enhancement in terms of continued operations. One solution has been prepackaged plans, where the proposed plan has already received support of key senior creditors prior to filing and the process is expedited in terms of notice, conducting of votes, and receipt of court sanction of the plan. Pre-packaged plans are increasingly becoming the norm, particularly in pro-debtor states such as Delaware.17 The difficulty is that the initiative for this process must come from the debtor corporation, and thus those utilizing Chapter 11 to defer liquidation are unlikely to use this process. Pre-packaged plans also risk reflecting only the interests of senior secured creditors, given that prior to formal proceedings, the debtor is likely to minimize transaction costs and negotiate only with those creditors whose vote will ultimately determine the outcome of the proceeding. Pre-packaged plans may therefore detract from the recognition of broader stakeholder interests. The 1994 amendments to the Bankruptcy Code also included a fast-track procedure for small businesses and single-asset companies. The problem is that it too is exclusively at the election of the debtor, and thus if the debtor corporation wants to delay the proceedings, it can easily do so. In 1997, a National Bankruptcy Review Commission made more than 170 recommendations aimed at enhancing reorganization proceedings and reducing delay in the U.S. workout process, and particularly at small businesses unable to successfully reorganize under the Code.18 However, the change in political power between the time the commission was appointed and its report, combined with increased lobbying by the credit industry has meant that these recommendations have not been implemented.19 The U.S. experience suggests that public policy promoting the ability of debtor corporations to restructure their affairs needs to be accompanied by a scheme imposing tight time frames, greater accountability, and closer supervision of the activities of the debtor corporation. In the Canadian scheme, that accountability is created in a number of ways. First, the stay of proceedings under the CCAA is not automatic

International Comparisons 237 and courts will refuse such applications if it appears that there is no chance of successfully restructuring the corporation's debts. Under both the CCAA and BIA, the initial stay period is short, and under the BIA, extensions of the stay can only be accomplished in forty-five-day periods to a total of six months. In contrast, the lengthy stay and periods of exclusivity under the U.S. regime can allow managers to deplete the assets available to satisfy stakeholder claims. The U.S. experience also illustrates that the public policy objective of promoting rehabilitation does not in itself adequately balance the diverse interests of those with investments at risk in the corporation. An effective scheme must ensure that decision makers are accountable and that negotiations for restructuring take place in a timely manner such that the investments of traditional creditors and other stakeholders are not further jeopardized. Moreover, public policy endorsement of the value of restructuring does not necessarily mean that the value of the enterprise will be maximized. Workouts in France: Early Intervention to Protect Stakeholder Interests France's regime is clearly situated as a rehabilitation regime. Insolvency and bankruptcy legislation, La Loi relative au redressment et la liquidation judiciare des entreprises, has as its express goal to encourage the prevention of bankruptcy and the reorganization of debtor corporations' debts.20 The objective of the legislation is not only to facilitate but also actively to encourage reorganization of debtor corporations experiencing financial difficulty. The reorganizing mechanism is called a redressement judiciaire. As with many jurisdictions, the stay provisions on enforcement of claims during negotiations for a restructuring are automatic. The unique feature of France's scheme is its focus on prevention of insolvency and on the role of the state, through its court system of Tribunal de commerce, in development and approval of restructuring plans. The strongest indicator of the regime's policy of encouraging workouts is the statutorily mandated goals of the legislation, which are threefold: to save the enterprise, to preserve jobs, and to pay creditors' claims. The legislation and the resulting caselaw have specified that these objectives are to be taken into account in strict descending order of priority in-the design and consideration of a redressement judiciaire.21 These objectives reflect the broader French corporate governance policy that encompasses employee welfare and long-term strategic planning

238 Creditor Rights and the Public Interest in addition to maximization of shareholder wealth.22 Thus France's legislation is even more explicit in its rehabilitation goals than the U.S. regime. Under a redressement judiciaire there is a six-month period of observation under a court-appointed official before liquidation is permitted. While this period is likely too long, the corporation enters the observation period much earlier in its financial distress. At the end of the period, the official is able to make an informed judgment as to whether the corporation should be restructured or liquidated. In 1986, the legislation was amended to limit considerably the personal liability of managers of the corporation, to encourage them to both enter the process earlier and to retain the skills of managers during the redressement period. However, even before formal proceedings are commenced, France's insolvency laws provide for early identification of corporate financial difficulty and thus prevention of insolvency and preservation and enhancement of creditor value. The regime requires extensive disclosure of financial affairs to state officials, workers' councils, and other stakeholders. The company's auditors must report directly to the board of directors when there is default on credit payments or other early warning signal of financial problems. The aim is to encourage corporate officers to respond quickly to possible financial difficulties. Disclosure of company financial reports and default in payments to the clerk of the Tribunal de Commerce is also mandatory. The court monitors this disclosure and will initiate preventive action for companies that appear to be headed towards financial distress. The court identifies financial weakness through the use of fairly advanced computer analyses that identify indicia such as increased litigation and high turnover of managers.23 Moreover, the auditor is required to report to the court if any default in payments is not resolved in a timely manner. Usually it is default on payments or signals from creditors that the firm is not meeting payment obligations that signals to the tribunal that intervention may be necessary, rather than broad monitoring of all corporations. There are both informal and formal mechanisms to provide assistance to the debtor corporation. For example, the president of the tribunal may summon a CEO for an informal discussion about the firm's financial affairs even before a restructuring proceeding is initiated. On the debtor corporation's consent, the court is empowered to order court-supervised mediation, reglement amiable (friendly settlement), in which the debtor corporation negotiates with creditors

International Comparisons 239

through the use of a court-appointed mediator to find an acceptable arrangement for meeting debt obligations. This may be undertaken with key creditors or all creditors, frequently in advance of insolvency, and it is undertaken under a rigorous secrecy requirement, the aim being to prevent the loss of corporate goodwill and customers. During these negotiations, the court may impose a stay against creditor enforcement proceedings, on the recommendation of the mediator. The reglement amiable is considered a critical component of the restructuring scheme, as it provides a forum and breathing space in which creditors and the debtor can try to find an arrangement acceptable to all parties. It resembles somewhat the court-supervised mediation process under the Canadian CCAA, although the intervention occurs much earlier and the mediation is conducted by business people or turnaround practitioners.24 The objective is to make the best use of business expertise while retaining expeditious access to the court if a consensual process does not succeed. The other notable feature of the French insolvency system is a 'triage' hearing in which the court decides at the outset of any formal proceedings whether there is any hope of successful reorganization. If not, the corporation is streamed into liquidation proceedings and sold either on an asset or a going-concern basis. Thus while the debtor corporation, the creditors, or the court itself can initiate a redressement proceeding, the decision as to where the debtor will be streamed is determined at a hearing convened by the Tribunal de commerce. Studies undertaken of the first ten years of the law indicate that 92 per cent of all cases filed ended in liquidation, but that the vast majority of these were identified at the outset of the case through the triage hearing.25 The early identification and elimination of firms with no chance of rehabilitation may be a measure of success of the system, because value to creditors is not unnecessarily depleted during a lengthy proceeding. Thus, the French regime works to resolve problems before the corporation enters into a redressement proceeding; failing that resolution, it works to identify only those firms with a chance of survival. These firms are then permitted to restructure their affairs through the redressement judiciare process. Redressement plans are considered, amended, or approved by the Tribunal de commerce, which is the court charged with adjudicating under the legislation. There is a dual track system, the ordinary restructuring and a simplified procedure aimed at companies with an annual gross revenue of less than 20 million francs and fifty or fewer

240 Creditor Rights and the Public Interest

employees.26 In the ordinary procedure, a court official called an administrateur judiciaire is appointed. The duties of the administrateur judiciaire range from monitoring the corporation, assisting existing managers, or actually taking over the day-to-day operation of the business, depending on the circumstances. The administrateur represents the state rattier than the creditors and thus can pursue the express objectives of the legislation with less conflict of interest. These officials are highly skilled in business decisions, financing, and turnaround management expertise. Under the simplified procedure, the court may choose not to appoint an administrateur, thus avoiding additional administrative fees. The duties of the administrateur judiciaire are similar to those of courtappointed officers in the Canadian regime, but entail a mix of duties resembling those of monitors, trustees, receivers, and restructuring officers. During the period of observation, the administrateur studies the debtors' business and develops a restructuring plan with the managers and other interests. Under the French scheme, the administrateur judiciaire always develops the plan, including designing proposals for the scheduling and rate of repayment.27 The administrateur reports to the court on the financial position of the debtor corporation, future prospects, the development of the plan, and its specific proposals. The court places considerable reliance on the expertise and advice of its officers, not unlike the Canadian regime. The administrateur can also sell the business as a going concern and the process involves elements of both restructuring and liquidation. This is viewed as complying with the legislative objectives of preserving an ongoing business and preserving jobs. To summarize, France utilizes policy instruments of extensive disclosure to creditors and other stakeholders, timely decision making, and accountability of managers during the period that creditors' rights are stayed. The French system is ultimately less concerned with who the ultimate owners of the corporation are than with preservation of the economic activity and firm wealth maximization. Enterprise Wealth Maximization as an Objective of Insolvency Law Previous chapters have suggested that an effective insolvency regime would include more express recognition of the objective of enterprise wealth maximization, as opposed to shareholder or traditional creditor wealth maximization. Of the two rehabilitation regimes, France

International Comparisons 241

alone appears to have shifted towards an enterprise wealth maximization model. This concept has not been endorsed in the United States insolvency regime; rather, the U. S. scheme aims at balancing shareholder rights with those of traditional creditors, the balance being clearly in favour of the debtor corporation. Where corporations are insolvent, directors have been found to owe a duty not just to shareholders but to creditors, and the courts have been inconsistent on whether this duty arises 'in the vicinity of insolvency' or once the corporation is insolvent.28 An objective of enterprise value maximization has not yet received explicit judicial endorsement, and rehabilitation is generally aimed at maximizing creditor value only to the extent of the liquidation value of their claims, after which the paramount objective is the survival of the firm. However, as previously noted, there is some evidence that in the health care, transportation and other service sectors, the courts do consider the impact of a firm's failure on continued availability of services and thus on the public interest. The courts have held that corporations may be deserving of special consideration in terms of how the rehabilitation or failure of the debtor will affect the community that is dependent on continued access to the quasi-public good.29 This consideration could in turn promote enterprise value maximizing objectives. Another impetus that may result in a shift towards enterprise wealth maximization is the increasing failure of U.S. firms in sectors in which there is no traditional security for credit, such as service, high-tech industries, retail, and supply chain financing. Here, there is likely to be a shift in restructuring financing and consequent control rights. In such cases, Bruce Markell predicts that workers, tax authorities, and tort claimants as non-traditional creditors will become the primary creditors in terms of reinvestment in insolvent firms.30 If this occurs, it may well encourage a move towards enterprise wealth maximization as a cost-effective way to measure the generation of value for the 'new investors/ although that value is likely to still be based on notions of equity ownership. A countervailing force to these trends is the large growth in claims trading both prior to and during bankruptcy proceedings. Distressed debt investors buy up claims across classes of creditors at severely discounted prices in order to acquire control rights across classes of voting creditors. This strategy influences the workout process. The difficulty, as identified by Gross and other scholars, is that the sellers

242 Creditor Rights and the Public Interest

of the claims, particularly more vulnerable groups, are often unaware of the value of the claim and thus trade them for considerably less than their realizable value. They may also be facing economic or physical hardship such that a severely discounted value today is their only real option, absent some sort of mechanism that would allow for interim payment of their claims.31 The distressed debt lenders who acquire control rights across classes are relatively sophisticated creditors who then exercise bargaining power to influence the workout in their own interests and away from an objective of enterprise wealth maximization. Recent court decisions that allow distressed debt lenders to acquire a vote for each small claim purchased confirm the ex post negative effects for an enterprise wealth maximization model. Judicial pronouncements requiring good faith and economic self-interest are unlikely to remedy the distributional effects of this trend.32 Girth suggests, however, that it could be remedied through the use of technology to broadly disseminate information regarding the value of claims, with the U.S. trustee playing a key role in web-based access to Chapter 11 information.33 Unlike the United States, France has explicitly moved towards recasting the objective of insolvency law to one of firm wealth maximization instead of maximization of creditor or shareholder wealth. Some scholars have suggested that the introduction of a more preventive and rehabilitation-oriented scheme in 1986 converted the French bankruptcy system from a legal regime to an economic one.34 This was accomplished by express recognition of the objectives of enterprise continuation, consideration of workers' human capital investments, and creditors' claims, albeit in a strict hierarchy as noted above. Given the legislative direction to consider all of those interests, the Tribunal de commerce and its court-appointed officer, the administrates, utilize the period of observation to devise a strategy to meet those objectives. The decision to restructure, sell on a going-concern basis, or liquidate the assets is then made having regard to how the value of the firm can be maximized. As suggested above, ownership of the firm is less relevant than devising a means to put the assets to their best use. A most interesting facet of the French regime is that enterprise wealth maximization is facilitated by the court-supervised process in which the economic and business decisions of the proposed redressement judiciare are adjudicated by the Tribunal de commerce. The Tribunal de commerce is comprised almost entirely of business people, sup-

International Comparisons 243

ported by lawyers, thus resembling somewhat Canada's administrative tribunal system, in which the adjudicators are frequently not justices or lawyers but rather representative of the stakeholders at which the legislation is aimed. The Tribunal de Commerce has broad remedial powers as a court. The underlying assumption of the legislation is that business people will be the optimal decision makers in terms of assessing the viability of any proposed restructuring plan. Thus business judgment is respected but takes the form of court supervision by those with particular expertise. The Tribunal de commerce's mandate also includes the ability to rework a proposed plan if practical experience dictates the necessity of doing so. Any decisions must be undertaken in accordance with the express objectives of saving the enterprise, preserving jobs, and paying creditors. The tribunal is empowered to approve a proposed plan of redressement, reject it, decide among competing proposed plans, or amend the plan to make it more commercially viable. The French insolvency system must be understood in the context of historically long periods of high unemployment and a long history of judicial and state intervention in corporate and commercial matters. The shift in France from a debt collection regime to a rehabilitation regime in the 1980s was precipitated by economic concerns that businesses should be given every opportunity to maximize value for the firm, within the context of an express objective of preserving where possible the employment of workers.35 Encouraging restructuring is viewed as an indirect means of economic recovery. While the French legal system is a rule-driven civil law regime, use of business people as the court of jurisdiction means that decision making is rooted in economic considerations. Deference to business judgments manifests itself in this regime through the manner in which the court is structured, as opposed to the U.S. model of high deference by the courts to business judgments made by corporate managers. France may have placed too much reliance on the court and its appointed officers, but the regime nonetheless addresses the issue of how to effectively assess business judgments in restructuring proceedings. The objective of enterprise value maximization has resulted in a regime with preventive triage and restructuring options that take account of numerous investments in the firm. Unfortunately, comprehensive empirical data to measure the outcomes of the system against the explicit objectives of the statute is not available.

244 Creditor Rights and the Public Interest

Recognition of Stakeholders' Equitable Investments in the Firm during the Restructuring Process In the two rehabilitation jurisdictions discussed, there is a paucity of information on the recognition of non-traditional stakeholders other than workers, and in the U.S. system, on tort claimants. Rights to participate in reorganization proceedings have generally been accorded only to those with capital claims. Reference to communities in the caselaw appears only indirectly in discussion of the overall rehabilitation goals of the regime, or of the need to balance environmental law with bankruptcy law.36 Here the schemes vary considerably. American bankruptcy caselaw and congressional debates on the U.S. Bankruptcy Code include many references to the impact of bankruptcy on workers and communities, and the U.S. regime indirectly gives weight to stakeholders such as communities through incentives to keep a firm in trouble operating and judicial encouragement of reorganization. Part of the justification for the debtor orientation of the scheme is the large numbers of employees and local suppliers who are usually not part of the decision to liquidate. The focus on survival indirectly represents their interests.37 As discussed above, where the railways were concerned, special provisions in American bankruptcy law required the court to ensure that a plan for reorganization was consistent with the public interest before sanctioning it.38 Julie Veach has suggested that this historical language regarding public interest should be imported generally into the U.S. Bankruptcy Code to offer a procedural mechanism by which the voices of parties with an interest in the debtor corporation, such as workers and communities, could be heard.39 As noted above, the courts have recently considered community or public interest in assessing bankruptcy proceedings involving corporations engaged in delivery of health care, transportation, utilities, and similar services, with the debtor and creditors making public interest arguments to further their own position.40 Karen Gross observes, however, that in doing so the courts tend to interpret notions of community narrowly, a function of their own backgrounds, which inform their consideration of issues and of who is arguing public interest before the court. She also observes that the increased use of mediation in some bankruptcy proceedings, such as that used in the Southern District of New York, may result in enhanced participation rights for greater numbers of stakeholders.

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Under the U.S. regime, unsecured creditors committees are important to negotiations for a reorganization plan and act to monitor some of the financial affairs of the debtor corporation through powers of investigation and disclosure. The practice has generally been to appoint the largest unsecured creditors to the committee as representative of the general body of creditors. Gross has suggested that creditor committees could become an important tool in according participation rights to stakeholders such as tort claimants, who might form separate committees or be granted better representation on existing committees.41 While others have expressed concern about the costs of multiple committees or the unwillingness of the judiciary to expand existing committees, the real expected transaction costs of such participation rights have not been weighed against the potential upside value that might be generated.42 Tort Claimants under U.S. Chapter 11 Proceedings The United States has recognized tort claimants as contingent creditors in terms of negotiations for a workout of claims and voting on a plan.43 The U.S. Bankruptcy Code defines creditors to include both current and anticipated tort claimants. Thus these claimants and their representative counsel have been involved in workout plans that include creation of trusts to meet current and future anticipated tort claims. While the genesis of this participation owed to efforts by otherwise viable corporations to limit liability and create access for tort victims to future income streams, the recognition has allowed for more expeditious and less costly access to remedies for tort claimants. Amendments to the U.S. Bankruptcy Code in 1978 expanded the definition of claim, paving the way for Chapter 11 reorganizations to be used as a vehicle to resolve mass tort actions such as Johns Manville (asbestos harms), A.H. Robbins (adverse health effects of the Dalkon shield contraceptive device), and Dow Corning (harmful health effects of breast implants).44 The device used to resolve such cases has been the creation of a trust from which claimants will receive a proportional share based on specified criteria such as harm or exposure. This recognition of tort claimants as stakeholders in a reorganization is a positive development, given the health problems, the immediate financial needs of these claimants, and the cost and delay of class action remedies outside of bankruptcy. However, as a tool to ensure survival

246 Creditor Rights and the Public Interest

of a firm and resolution of mass tort actions, the trust fund has both positive and negative consequences for tort claimants. In 1994, based on the success of early asbestos related-workouts, the U.S. Congress enacted provisions to facilitate restructuring of corporations facing mass asbestos tort claims.45 Pursuant to these provisions, half of the debtor corporation's reorganized equity must go to the trust fund and 75 per cent of existing claimants must vote to approve the plan. To date, more than 500,000 individuals have filed more than 10 million asbestos-related claims in the United States, with the estimated total cost of asbestos mass torts approximately $275 million.46 The asbestos provisions allow a Chapter 11 workout to discharge all liabilities against the corporation for both current and future tort claims. Extensions by the debtor corporation to the stay period can mean costly delay of remedies for tort claims, costly both financially and in terms of adverse health consequences. The trusts must be structured to allow for claims of both personal injury and property damage, and the personal injury claims are divided into present and future claims.47 While the Code requires that a representative be appointed to represent future tort claimants in the reorganization proceedings, it is not clear that this mechanism can adequately represent classes of tort claimants who do not yet know they exist. There is also a problem with ex ante determination of the amount of trust funds required to be set aside for the future satisfaction of claims, when no one really knows the full extent of harms. A further question arises as to the constitutionality of the courts binding future tort claimants, who have been exposed to the past actions of the corporation but the harms have not yet manifested themselves.48 Binding future tort claimants, without either due process or relative certainty in the amount of money that needs to be vested in the trust to cover their claims, can work to disenfranchise future tort claimants. Michelle White has also observed that the trust approach may create inequitable outcomes: the broad-brush approach of satisfying claims without sufficient auditing of their merits, while reducing transaction costs, also reduces the pot of money available for those suffering serious adverse health consequences, and may even encourage fraudulent claims.49 In some cases, payment amounts are reduced as it becomes evident that the amounts set aside in trust were insufficient. She observes that none of the recent trust funds has been well-funded, suggesting that managers may have become more skilled at transferring

International Comparisons 247

assets out of reach of asbestos tort claimants prior to filing or more adept at negotiating more favourable terms.50 Canada has had considerably less experience in insolvency proceedings and the use of trust funds as a workout tool. The Red Cross case discussed in chapter 7 was the first case to address these issues. The U.S. experience suggests that the public interest considerations in creating these trust funds and limiting the future liability of corporations require further study. Workers, Unions, and Section 1113 of the U.S. Bankruptcy Code Job preservation is often cited as a key reason for allowing Americanbased debtor corporations the opportunity to develop plans of reorganization. Yet there are several important observations to be made. First, recognition of the value of preserving job rights has rarely translated into participation or decision rights. The exception may be where workers actually purchase the insolvent company, although this is often on a share-purchase basis that does not accord workers any governance role in the corporation. Employee share plans post-reorganization create the same collective action problems faced by shareholders, exacerbated where Employee Stock Ownership Plans (ESOPs) do not afford workers' shares even the same default governance rights as common shares. Absent more institutionalized governance change, as in the Algoma Steel case in Canada, this can create further risks for workers. Second, while the extended period during which the corporation can remain under the protection of the court preserves jobs for that period, the relief can be temporary or illusory. Workers often continue their human capital investments, thereby increasing the amount of investment at risk if the firm ultimately becomes bankrupt. This loss is heightened by their further investment in the debtor through wage concessions, and reduced pension and employee welfare benefits. Workers continue to make firm-specific undiversified investments which are lost when the firm is ultimately liquidated. Often they have not used the period of further investment to secure alternative employment because of information asymmetries and firm loyalty, the latter being a further indicator of their residual or equitable interest. Under the Canadian regime, a restructured corporation is bound to any collective agreements in place prior to the restructuring. This includes new purchasers, who are bound under the successor rights

248 Creditor Rights and the Public Interest

provisions of provincial and federal labour relations statutes. Thus the Canadian statutory scheme protects the capital claims of workers under collective agreements. Practically speaking, however, unions frequently bargain for a compromise of their members' claims under collective agreements because this better protects workers' investments in the firm and is preferable to bankruptcy and termination of employment. The Canadian insolvency regime does not include as one of its policy instruments the repudiation of collective agreements. In contrast, the U.S. scheme does allow for repudiation of collective agreements if certain conditions are met. This substantially reduces the protection afforded by successor rights protection in U.S. labour law. In the context of U.S. bankruptcy law, collective agreement repudiation is given special treatment within the Code's broader scheme regarding the repudiation of executory contracts. Section 1113 of the U.S. Bankruptcy Code, which deals with the repudiation of collective agreements, was enacted in response to the United States Supreme Court decision in NLRB v. Bildisco, in which the court held that collective agreements are executory contracts within the meaning of the Bankruptcy Code.51 The court in Bildisco upheld the right of a debtor corporation to reject a collective agreement and to unilaterally implement changes in terms and conditions of work without violating the National Labour Relations Act. As a result of public outcry following the Bildisco judgment, the Bankruptcy Code was amended to include section 1113, which specifies both procedural and substantive conditions governing the rejection of collective agreements under Chapter 11 proceedings.52 The provision is viewed as a compromise between bankruptcy reorganization principles and labour law principles.53 Interestingly, section 1113 was intended to recognize the special nature of workers' investments in the firm, to allow the debtor corporation to control costs post-workout, and to allow the court to balance diverse economic interests in development of a reorganization plan. These notions are similar to the ideas canvassed earlier in this book. In the context of a debtor-oriented bankruptcy scheme that allows for the repudiation of executory contracts, section 1113 benefits workers and provides some opportunity to bargain. In the context of a more creditor-oriented scheme, the provisions work to diminish even the fixed capital claims of workers, by allowing those claims to be unilaterally set aside. In interpreting the provision, the U.S. courts have failed to reach consensus on the tests to be applied.

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While labour costs are an important issue facing reorganizing corporations, the section 1113 caselaw has spawned considerable debate and criticism from scholars and practitioners. Some argue for a form of final offer arbitration as the instrument for amending collective agreements during a reorganization proceeding.54 This would reduce opportunistic behaviour by parties in negotiating modified agreements. Although the U.S. courts have spoken of balancing the equities, in reality a debtor company can unilaterally reject the collective agreement.55 The requirement that unions must privilege the economic needs of the corporation appears to neglect the fact that unions have negotiated collective agreement language over many years in recognition of human capital investments, and it is these investments they seek to protect. It also fails to recognize that unions have a fiduciary obligation to their members. Thus while the language of section 1113 invokes consideration of workers' interests, human capital investments are recognized only indirectly through section 1113 requirements in unionized workplaces. Collective agreements fare only marginally better than executory contracts.56 The ability of the debtor corporation to reject the collective agreement creates additional litigation and adversarial relations among workers, unions, and corporations. This reduces the likelihood that they can reconcile their diverse interests without intervention of the court, which in turn creates delay and adds considerable transaction costs to the reorganization process. Moreover, given that the union's resources must be directed to defending existing agreements, its members are less likely to focus on an effective governance strategy to assist the corporation in turning around its financial affairs. The U.S. experience differs from recent developments in Canada, in which creditors and the courts have been willing to involve unions in the restructuring process. The only positive development in U.S. caselaw is that courts have held that where a union makes a compromise proposal that meets its needs while creating savings for the debtor, the court will find that the union had good cause to reject the proposed repudiation.57 However, these participation rights are essentially negative rights. Unions are permitted to defend the gains that they have bargained for previously only if they can craft proposals that generate the same kind of savings to the debtor corporation. Interestingly, the U.S. courts have held that once a corporation becomes insolvent, creditors' interest becomes an 'equitable interest' in the assets of the corpo-

250 Creditor Rights and the Public Interest

ration such that a fiduciary duty arises.58 While this finding of equitable interest was not made with respect to workers' human capital investments, the court's recognition of a notion of equitable interest once the firm is insolvent may be an avenue that workers and unions could pursue in the future in seeking enhanced participation and decision rights. One hurdle that workers will have to overcome in the process is an existing U.S. Supreme Court pronouncement that labour, experience, and expertise do not constitute 'capital' within the meaning of 'value-added' under U.S. bankruptcy law.59 While decided in the context of specific provisions designed to determine when shareholder equity is preserved, this finding may nevertheless present an initial barrier to a more expansive judicial interpretation of workers' human capital as an investment that should be valued in the workout process. Recognition of Human Capital Investments in France The recognition of human capital investments in France's insolvency law is facilitated by the express statutory language that has job preservation as an important objective. French law adopts a variety of instruments for protecting workers' interests. For example, France has established a national wage earner protection fund as the optimal means of protecting employees from insolvency. The recognition given to workers' interests in the restructuring scheme thus complements other policy tools aimed at minimizing harm to workers from firm failure. The role of workers, which prior to 1986 was that of ordinary creditors, has been enhanced in France's restructuring scheme. Worker representatives, as well as creditors, can initiate bankruptcy proceedings, and once initiated, the onus falls on the directors of the debtor corporation to demonstrate that the firm is not insolvent.60 A representative of labour is appointed by the court to be heard on substantive issues regarding the reorganization of the corporation. The workers' councils, les comites d'entreprise, select the workers' representative. Corporations are required to disclose financial statements and forecasts to workers' councils in advance of entering formal restructuring proceedings. Workers are given voice and participation rights, and their advice is considered by the courts and their appointed officers in the determination of whether to restructure or liquidate the firm. This not only addresses the problem of information asymmetries but allows

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workers' councils to contribute their informational capital to the governance of the corporation. Under the French scheme, if more than one commercially viable redressement is proposed, and one plan preserves jobs whereas the other provides for the greater payout of creditors' claims, the court is required to chose the former by virtue of the higher public policy recognition given to preserving jobs.61 The scheme aims first at ensuring that plans are commercially viable, utilizing the business expertise of the court. Within those possibilities it creates a hierarchy of interests to be considered, with workers' jobs ranking higher than the satisfaction of traditional creditors' claims. This reflects a public policy view that traditional creditors can bargain a risk premium and workers generally cannot. Court-appointed officers play a key role in the successful consideration of stakeholder interests and mediation of a negotiated resolution to the firm's financial distress. The administrateur in the redressement proceeding or the mediator in the reglement amiable use their business expertise and are key to making a frank assessment of the debtor corporation's prospects. They ensure that a greater role is given to creditors and workers in assessing and influencing the design of a viable plan. Part of the mandate of the administrateur is to consider the needs of workers and the interests of community. Thus, its role in facilitating a negotiated resolution also involves ensuring that those interests are expressly accounted for in the workout. Reconciling the Rights of Traditional Creditors and Other Stakeholder Interests One might assume that a rehabilitation regime ignores the interests of creditors. This is far too simplistic an analysis, not only because of the diverse interests of creditors, but also because restructuring regimes can advance the interests of creditors as well as debtors. For example, as discussed above, in the United States, secured creditors' interests are protected by the absolute priority rule (APR), which requires that each class of creditors be paid in full in cash or securities prior to the receipt or retention by any junior class of creditors or shareholders of any property or interest in the reorganized entreprise.62 While secured creditors can negotiate less than this value in the plan, they are not required to do so, and the debtor corporation is thus encouraged to

252 Creditor Rights and the Public Interest

develop proposals that creditors will endorse. Absent a negotiated settlement, the court will not sanction a plan that does not comply with the APR. These traditional creditors' rights are counterbalanced by the cram-down provisions available only to the party proposing the plan, usually the debtor corporation, given the prolonged exclusivity period. In such cases, the court may sanction a plan over the objection of dissenting creditors if it is persuaded that the plan does not discriminate unfairly and is fair and equitable with respect to any interest impaired that has not accepted the plan. To determine this, the court determines the value of the interest in order to satisfy itself that the dissenting creditor has received at least what it would have received in liquidation. The cram-down provision can benefit the debtor corporation because it ensures that the plan will not be defeated solely because a key creditor has not endorsed it. It can also benefit dissenting creditors in that their liquidation value interests are guaranteed and because of the statutory prohibition against unfair or discriminatory treatment.63 However, the APR can create incentives for managers and senior creditors to squeeze out lower priority creditors in the reorganization.64 Bebchuk and Fried have suggested that the APR causes excessive use of secured interests, distorting the monitoring arrangements of creditors and reducing the incentive of firms to undertake adequate risk assessment.65 The APR does assist somewhat in protecting traditional creditor rights by ensuring that any proposed reorganization plan does not unduly disadvantage creditors. However, at the point of insolvency, creditors' claims are particularly time sensitive and the process of valuing these claims means that value accruing to creditors can be seriously diminished during the period that parties contest valuation. This diminution, combined with the delays inherent in the stay process, can work to seriously compromise creditors' claims. As a result, if the parties can negotiate a reorganization plan in a reasonably timely way, creditors will compromise their claims to preserve as much value as possible. Several studies have found that most Chapter 11 reorganizations provide only slight variations from the APR in favour of shareholders and some creditors.66 Creditor interests under the U.S. scheme are also somewhat protected because once the corporation becomes insolvent, the courts have held that its directors acquire some fiduciary duty to the creditors. This fiduciary duty may arise when the corporation is in the Vicinity of insolvency' or when it actually becomes insolvent. While there is

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some uncertainty as to the scope and timing of that duty, directors are prohibited from decision making that benefits managers, shareholders, or preferred creditors to the detriment of other creditors.67 Lin suggests that the U.S. courts have not expanded the scope of fiduciary duty to creditors or recognized a separate duty; rather, they have rendered judgments that address breaches of existing contractual obligations of parties under the language of fiduciary obligation or find culpable behaviour in the form of fraudulent preferences or illegal diversion of assets.68 This differs from the notion that directors are to undertake decision making with a view to maximizing the return to creditors. In Credit Lyonnais Bank Nederland, the court held that directors of a corporation in the vicinity of insolvency should view the corporation as a 'community of interests' and undertake business decision making to maximize the value of the estate having regard to that entire community of interests.69 This indicates some willingness by the courts to require directors to make a reasoned effort to balance all of the competing interests, including creditors and equity owners. However, this reasoning has not been uniformly followed, creating some uncertainty. As noted above, in some recent health care and utilities cases, the courts have made similar references to notions of community or the public interest. The issue is whether the courts will expand these notions to require directors to consider the interests of non-traditional creditors. Another issue that concerns American scholars is that if a creditor has exercised control over an insolvent corporation and has engaged in inequitable conduct, including unfair advantage to the creditor, the court can subordinate its claims to those of other creditors.70 Yet where creditors do not assume some control, the directors are ostensibly fiduciaries of the DIP under Chapter 11. The directors have a fiduciary obligation to both shareholders and creditors, the rationale being that this is the quid pro quo for temporarily suspending creditor rights to enforce their claims. Since the courts continue to exercise considerable deference to business judgments, dual obligations to creditors and to the shareholders that continue to elect directors can work to undermine the interests of creditors.71 As noted above, directors have an inherent conflict in that they are bargaining on behalf of the shareholders with creditors for a workout, yet they also have an obligation to creditors. In the United States, widely held credit creates serious collective action problems for creditors in terms of monitoring the reorganization process. Only a small minority of American reorgani-

254 Creditor Rights and the Public Interest

zation proceedings involve creditors' committees. Although trustees are only rarely appointed to take over operations during reorganization proceedings, increasing use is being made of statutory provisions allowing for an 'examiner' to investigate, provide information to creditors and the court, mediate negotiations for a workout, and monitor the activities of. the debtor corporation.72 The duties of the examiner resemble those of a monitor in CCAA proceedings. Thus the statutory language of the U.S. Bankruptcy Code appears to afford traditional creditors substantive rights to protect their claims during restructuring. The APR rule, the protection of the liquidation value of their claims under the cram-down provisions, being the beneficiaries of fiduciary obligation, and increased use of examiners, all serve to ensure that traditional creditors' rights are preserved. However, given all the factors favouring rehabilitation, discussed above, these rights are frequently seriously compromised because of the problem of deferred liquidation. Prejudice to creditors' interests from excessive delay and opportunistic behaviour by corporate officers highlights the need for timely and cost-effective court-supervised processes that will prevent the unnecessary further depletion of value. While there is some question as to whether France's model offers the optimal balancing of interests, it has nevertheless attempted to balance traditional creditor rights with other interests articulated as priorities under the scheme's objectives. The French regime has eliminated some of the control rights of creditors and undertaken a more balanced consideration of all stakeholder interests. Prior to the 1986 law, a creditors' committee, called a syndic, was actively involved in approving both operating and restructuring management decisions.73 The decision to eliminate these control rights arose out of the view that such control was often exercised to defeat the goal of successfully reorganizing the debtor corporation. Further statutory amendments in 1994 re-established creditors' committees or advisory groups of up to five creditors but did not restore the control rights they previously exercised. This action was taken in response to concerns that the legislation had moved too far away from traditional creditor rights. The mandate of these committees is to assist the court in overseeing the administration of the debtor's operation. Under the current law, creditor participation in the reorganization process is thus less prominent, although the administrateur judiciare and the mediator under the reglement amiable process must ensure that the views and interests of creditors are considered in the workout or design of the plan.

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The interests of creditors are also recognized and balanced in other ways. Creditors can initiate redressement proceedings and unless the debtor corporation can establish its solvency, the court will intervene. Moreover, no creditor can be compelled under a plan of redressement to accept less than 100 per cent of its claim, although payments can be stretched over an extended period to a maximum of ten years. Thus there is no equivalent of the American cram-down of creditors' claims or forced acceptance by majority and value of claims in a class, as provided for in the Canadian regime. Creditors can agree to less than 100 per cent realization and a faster payout period, or a combination of the two. Priority of payment is similar to that mandated in the American priority system. The proposed plan of redressement is circulated to creditors and, while it is hoped that a majority is supportive of the plan, there is no creditor vote.74 The underlying assumption of France's system is that creditors can negotiate in the informal, court-mediated process. Once that fails, creditors have largely lost their opportunity to influence the development of the process, as they can still require full payment of claims. Under redressement, the administrates can reject uncompleted contracts, and debts due in the future are not accelerated to the present when the firm reorganizes.75 Under French law, however, where the courtappointed administrateur judiciaire sells the business as a going concern, the creditors are no longer entitled to a 100 per cent return. Rather, the proceeds of the sale provide a fund in which debts are satisfied on a formula basis.76 While these rehabilitation regimes have as an objective the protection of creditor interests, the instruments to accomplish this goal vary considerably. Where the scheme accords control to the debtor corporation, protection of creditors' interests comes in the form of a veto or the ability to receive payment for the full amount of claims in advance of approval of the plan and prior to satisfying the claims of more junior interests. Lessons from Creditor-Oriented Jurisdictions Jurisdictions that are debt collection- or creditor-oriented are by their nature not particularly conducive to the framework suggested in this book. Debt collection regimes focus almost entirely on the objective of satisfying creditors' claims in a cost-effective manner, based on the hierarchy of security set out in the particular scheme. Rehabilitation is

256 Creditor Rights and the Public Interest

not a substantive objective of the regime, and thus the discussion here may seem somewhat thin. However, recent and important changes illustrate a slight recognition that a developed insolvency regime requires multiple instruments to address firm financial distress. Moreover, many creditor-oriented regimes have adopted other policy instruments to complement the insolvency regime, which they believe better protect workers' and others' losses on corporate insolvency. For example, the United Kingdom has a wage earner protection fund,77 as does Germany. Germany's wage earner protection fund is administered by its national unemployment insurance fund, which receives almost 170,000 claims annually. Germany also recognizes workers' human capital investments by employing co-determination models of corporate governance both at the supervisory level and in workers' councils. Workers are not accorded special rights on insolvency, because they have already exercised governance and monitoring earlier in the process. Policy choices about restructuring must be viewed in the context of the larger policy objectives and instruments chosen to complement the corporate and insolvency law regime. Even debt collection regimes have recognized the value in creating a workout instrument. For example, in Germany, until recently, there was virtually no mechanism for debtor corporations to restructure their affairs. The regime is highly debt-collection oriented. The predominance of private liquidation meant that in many cases the issue of whether a restructuring would generate greater value for all of those with interests at risk was never explored. However, creditors and commercial practitioners found that the failure to provide a restructuring mechanism as one component of the system resulted in an excessive number of premature liquidations. Thus, recent statutory changes have enshrined for the first time a mechanism to allow debtor corporations to devise restructuring plans. The European Bankruptcy Regulation, in force as of May 2002, will lead to further developments, as EU member states work on cross-border harmonization of highly divergent systems.78 One of the difficulties in comparative analysis in this context is that the governance regimes of corporations differ considerably prior to insolvency. Thus, there may be different considerations in the governance of the insolvent corporation. For example, in countries such as Japan or Germany, creditor monitoring, especially by the banks, plays a central role in governance of the solvent corporation. This role is reinforced by the fact that the banks also hold considerable equity in

International Comparisons

257

the firm, either in the form of direct equity ownership or by use of proxy power over customers' shares on deposit.79 Moreover, in Germany, corporations are more highly leveraged than in many AngloAmerican jurisdictions and the vast majority of debt is secured. While unsecured claims can be compromised, such an exercise is useless unless the scheme allows for an arrangement that binds secured creditors. Germany's Insolvency Act Germany adopted a new Insolvency Act in 1994, effective January 1999.80 Previously, no formal mechanism existed for the restructuring of insolvent corporations and less than 1 per cent of insolvent firms tried to reorganize. Filing for bankruptcy protection was very expensive and the courts frequently rejected such applications on the basis that the corporation did not have sufficient assets to pay for the proceedings. Thus such proceedings were almost never utilized. Moreover, there was no automatic stay, creditors were free to terminate the proceedings at any time, and they had veto power on any compromise of claims. The impetus for the revised legislation was the recognition that firms were being liquidated prematurely and that the average enforcement of claims netted about five cents on the dollar. The product of more than two decades of debate by legislators and insolvency practitioners, the German Insolvency Act is modelled on many of American scholar Thomas Jackson's debt collection theories, but it provides for a reorganization procedure.81 Christof Schiller has observed that with only three years' experience with the new legislation, it is too soon to assess whether the scheme will be effective.82 The policy objective of the new law is to maximize creditor value, and to this end, the law seeks to eliminate collective debt enforcement problems. Thus, while the legislation provides for the negotiation of a restructuring plan, an Insolvenzplan, as one option to maximize creditor value, unlike the jurisdictions discussed above, the law is indifferent as to whether creditor value will be maximized through reorganization or liquidation. The regime does not consider the continuation of the corporation as a goal per se; it is aimed at determining whether reorganization is the optimal means of maximizing creditor value. All insolvency proceedings in Germany commence as liquidations, and thus the onus is on the debtor corporation or creditors seeking a

258 Creditor Rights and the Public Interest

workout to persuade the court that the case should be converted to a reorganization case.83 The court must be persuaded that there are sufficient funds to pay for the workout procedure. It must also be satisfied that there is 'cause for insolvency/ a defined term under the statute that includes over-indebtedness or the inability to pay debts when they fall due.84 The debtor corporation can also establish cause for insolvency where the corporation faces 'imminent insolvency,' a provision designed to encourage debtor corporations to file for bankruptcy at an early stage. In contrast, creditors must wait until the debtor corporation is insolvent before they can act. While the legislation grants the court discretion to allow the debtor to retain possession of the corporation's assets, to date the courts have been reluctant to exercise this discretion and in most cases they appoint an insolvency administrator.85 Even where the debtor corporation, with the consent of key creditors, makes an application to the court to continue to operate, the court will only make such an order if it does not unduly prejudice the creditors and only with the supervision of an insolvency practitioner. If the chance of loss of control on filing is great, corporate officers may be reluctant to enter insolvency proceedings, even though the law is ostensibly designed to encourage managers to file earlier. Reorganization plans in Germany can propose to modify creditors' statutory rights, restrict the debtors' rights with respect to protection of assets, set rules for the distribution of proceeds from an asset sale, engage in a full liquidation, set out the liability of the debtor corporation when the plan is implemented, or provide for the sale of the business as a going concern.86 The plan must describe the transactions proposed to reorganize the business and satisfy creditors' claims, including the reasons for insolvency and the results anticipated from the proposed changes. If the plan proposes repayment of creditors' claims through future profits, it must include detailed calculations and projections of future profits and cash flows to establish feasibility.87 The larger and more complex the debt structure of the debtor, the more costly and time-consuming these calculation requirements become. This acts as a further impediment to a successful Insolvenzplan. Creditors are divided into classes, called 'groups,' and the creditors of each class must be treated equally, unless all creditors in a particular class consent to another arrangement. Other than dividing secured and unsecured creditors and creating a separate class for workers, where their claims are considerable, the debtor has considerable discretion in the determination of class.88 It must, however, provide a rational for a particular grouping of creditors in a class.

International Comparisons 259

The German scheme does not automatically stay creditors' rights to enforce, and there are complex rules as to when various classes and priorities of creditors can take action to enforce their claims.89 Thus, there is often a direct conflict between creditors' rights to enforce claims and the ability to devise a plan of reorganization. Similarly, creditors have wide-ranging rights in terms of appointing an administrator to manage the corporation or to replace the creditors' committee. It is the creditors' meeting that determines whether the corporation will be restructured under the control of existing shareholders and managers or sold on a going-concern or liquidated basis.90 Thus the focus is not only on creditor value maximization, but also on creditor control of the process. Similarly, creditors vote on any restructuring plan by class, and the plan must be approved by each impaired class of creditors in accordance with a specified minimal level of approval, expressed as a percentage of the number of creditors and a percentage of the total value of claims in the class. The court has little discretion in sanctioning the plan, other than to deal with procedural violations, and the decision of the creditors is paramount to the determination of whether to reorganize or liquidate. The exception is where a creditor applies to have a plan set aside and the court has jurisdiction to determine that the plan is detrimental to the interests of the creditors as a whole. There are numerous provisions specifying that the wishes of the majority of classes prevails if objecting creditors are given an 'adequate share' in the payout of claims.91 Criticisms of the new law point to the failure to structure creditors' negotiations, and the inability of administrators to swiftly determine whether the corporation should be reorganized or liquidated.92 The inability of the administrators to act effectively means a delay in decisions regarding retention of employees and trade suppliers. Only the debtor corporation or the administrator, on request of the creditors, can propose an Insolvenzplan. If creditors have resolved to liquidate the firm, the court will not consider a proposed Insolvenzplan by the debtor corporation. The legislation also does not allow debt equity swaps or reorganization to preserve pre-existing equity. This may create pre-insolvency incentives for managers' decision making, as discussed in chapter 2. Moreover, there is no mechanism to relieve equity owners or other parties of third-party guarantees, again creating incentives to avoid insolvency proceedings as long as possible. German law requires corporate officers to file for insolvency within three weeks of learning the company is insolvent or over-indebted. Schiller observes that this requirement works against developing a culture of

260 Creditor Rights and the Public Interest

pre-packaged plans, which arguably could be more timely and costeffective, because corporate officers are unlikely to risk being scrutinized by government prosecutors as to the time frame for reporting the insolvency.93 The system has also been criticized because the onerous statutory requirements lead to unnecessary delay, litigation costs, and proceedings on the question of how best to maximize creditor value.94 The costly valuation process where the plan includes future payment also tends to drain corporate resources to hire expertise to formulate these projections. Since the system envisions a limited form of cram-down, the value calculations are critical to the court's endorsement of an Insolvenzplan. As the German model illustrates, the issue of transaction costs needs to be addressed across all types of schemes. Also critical is that debtor-in-possession financing has not really developed in Germany. Hence financing that allows the corporation to continue operations and devise a viable business plan is frequently not available, creating a serious barrier to access to the restructuring provisions. Although banks will provide interim operating financing, absent bank support of the Insolvenzplan, there is almost no access to new financing.95 One study reports that in the first two years of the new legislation, there were only a hundred Insolvenzplans compared with more than 27,000 business insolvency procedures and liquidations. In the United States in roughly the same period there were more than 8,000 reorganization proceedings out of approximately 44,000 bankruptcies.96 The differences are attributable not only to the barriers described above, but also to the fact that this regime is new to Germany. Practitioners, debtors, creditors, and the courts used to the centuries-old liquidation model, will need time to become familiar with the new system. The plans that have been successful in Germany to date are those where the debtor or administrator has persuaded creditors, trade suppliers, and customers that there is value in a continued business relationship.97 Workers appear not to be a consideration in the development of the Insolvenzplan, other than as ordinary creditors. However, under the German scheme, the court and its officers will receive advice from workers' representatives prior to endorsing a plan to liquidate, sell as a going concern, or to restructure.98 Moreover, the German system of co-determination entails workers having at least some access to governance structures through their participation on Aufsichtsrat, supervi-

International Comparisons 261

sory boards that oversee performance of the management board." The assumption may be that workers do not require special attention during insolvency because they are accorded participation rights in the solvent corporation. When the new law was being drafted, the commission that formulated the legislative proposals included representation by German trade unions.100 The focus on traditional decision rights in the Insolvenzplan may well be intended to complement existing national insurance schemes that help workers with adjustment losses, retraining, and protection of their human capital investments. A truly effective comparative analysis requires study beyond a comparison of the single policy instrument of restructuring, and is thus beyond the scope of the present chapter. The System of Administration in the United Kingdom The United Kingdom is another example of a debt collection regime and many of the same caveats apply with respect to not viewing the regime in isolation from other policy instruments that accord value to human capital investments. Prior to 1986, the regime was almost entirely creditor-oriented, resulting in a number of premature liquidations.101 The 1986 Insolvency Act was aimed at moving the United Kingdom slightly towards a rehabilitation system through the creation of an 'administration' where a corporation becomes insolvent. Residual interests by shareholders in receivership had previously not been preserved, as is now possible under an administration. However, the objective of the system remains essentially one of debt collection and it creates at best a mechanism whereby dissenting creditors are controlled.102 Prior to 1986, the U.K. scheme was essentially one of liquidation through receivership. Extensive review into insolvency and bankruptcy resulted in the new legislation, which provided for a restructuring scheme for the first time.103 Part of the impetus for these changes was a report by the Insolvency Law Review Committee in 1982, commonly referred to as the Cork Report. The Cork Report explored the implications of corporate failure, concluding that modern insolvency law must have regard for the effects of insolvency on creditors, employees, and the community at large by creating a rescue mechanism.104 A debtor corporation now has access to court protection through stay provisions while the company tries to work out its affairs. Administration is conceived of as a temporary period during which the parties attempt to formulate a long-term resolution to the debtor corporation's finan-

262 Creditor Rights and the Public Interest

cial distress. The administration process is initiated by a petition, filed by the company itself, the directors, or by creditors, where the debtor corporation is unable or likely to become unable to pay its debts. The petition must specify that the financial difficulty may be remedied by one or more of: the survival of the company as a whole or any part as a going concern; the approval of a voluntary arrangement under the Insolvency Act; a sanctioning of an arrangement or compromise under the U.K. Companies Act, 1995; or realization of assets under relevant winding-up legislation. The statute specifies a long list of persons who may appear at the petition hearing, including shareholders, creditors, and, with the court's leave, anyone 'who appears to have an interest justifying his or her appearance.'105 Thus while it is uncertain whether any non-traditional creditors or stakeholders have sought access to the process, the legislation explicitly allows the courts discretion to hear from such parties. This is potentially a significant development in U.K. law in terms of the types of participation rights advocated in this text. Andrew Keay observes that insolvency law in the United Kingdom has been viewed primarily as private law, aimed at the rights of creditors against debtors. The public interest element of the regime has attracted almost no debate in that jurisdiction. Yet he also notes that insolvency law has become increasingly concerned with the social and economic effects of firm failure, including job loss, the spin-off loss of business for the community, and reduction in local tax base and public services as people move out of the community to seek employment elsewhere. Thus, in the United Kingdom as elsewhere, it is in the public interest to provide a corporate rescue mechanism that allows an insolvent company to continue in business.106 Public interest is implicated in the collective process to realize on debts, in the retention of jobs and local economic activity.107 As with the Canadian restructuring scheme, under an administration the court is called upon to determine a variety of orders and it has broad discretion. The decision to place the debtor corporation in administration is itself discretionary and left to the court.108 Under the U.K. scheme, the directors and officers of the corporation relinquish power and control on appointment of an administrator.109 The administrator is appointed by the Companies Court of the Court of Chancery and is an insolvency practitioner. Frequently, senior managers remain, and these managers or creditor-appointed replacement man-

International Comparisons 263

agers represent the interests of the debtor. A creditor or a shareholder (called a member) can apply to the court for remedies if the conduct of the administrator appointed has been unfairly prejudicial to its interests.110 Thus there are some accountability mechanisms that afford at least some stakeholders access to the process. The administrator has broad powers to order disclosure and is to represent and protect all creditor claims. Since the administrator is not appointed by a single creditor, it may have greater flexibility to determine whether an effective restructuring plan can be developed and accepted by creditors. The administrator has strong powers to stay or delay creditors' claims during the plan development stage, and up to three months to decide whether to restructure the corporation, sell it as a going concern, or liquidate it.111 The administrator can assist with the development of a restructuring plan, called a scheme of arrangement. The scheme of arrangement must be sanctioned by the court and requires the support of 75 per cent of each creditor class vote in order to receive court approval. The role played by the creditors at the meeting at which the administrator's proposals must be considered is key to the assessment of whether the firm has a viable plan. The approval requirements include the ability of creditors to modify the proposal, again providing an accountability mechanism to ensure that creditors' interests are taken into account. Appointment of an administrator is most valuable when the interests of creditors are highly divergent. In these circumstances the administrator can ensure that decision making occurs with a view to maximizing firm value to the benefit of all creditors.112 The administrator must liquidate the firm if the liquidation value exceeds that of going-concern value.113 The aim of the new U.K. scheme is to reduce the incidence of premature liquidation while preventing deferred or delayed liquidation. Where no deviation from creditors' claims and priority is allowed in receivership, some compromise is allowed in administrations. The scheme provides for a stay of secured creditors, whereas no such stay is in effect for a private workout or a receivership. Given the primary policy objective of debt collection, however, the slight movement towards a restructuring orientation has been accompanied by a number of accountability measures aimed at minimizing losses to creditors. For example, directors are required to disclose financial distress in earlier stages, failing which they can be disqualified from holding a board directorship for up to fifteen years.114 From 1998 to 2000, 2800

264 Creditor Rights and the Public Interest

disqualification orders were made, and recent statutory amendments will obviate the requirement for a court disqualification order where there is an agreement on a period of disqualification.115 While creditors are minimally involved in the process, the period for developing and approval of an administration is relatively short, often only a few weeks or months.116 The effectiveness of the administration system has been difficult to measure. Initial studies indicate that despite some unevenness in judicial interpretation, the courts have on the whole exercised their discretion to facilitate restructuring and workouts under administration orders.117 While administration theoretically allows debtor corporations to compromise or shift priorities in order to facilitate successful restructuring, a study of cases in the first seven years did not indicate that the regime had actually moved in that direction."8 Adequate incentives have not yet been established to encourage creditors to negotiate for a reorganization that would create added value for their interests instead of moving to enforce their claims. Rajak cautions against concluding that the scheme is ineffective because of the high number of liquidations, since an express objective of the administration scheme is also to allow for administration orders that provide 'a more advantageous realization of the company's assets than would be effected on a winding up.'119 Once the petition for an administration order is before the courts, the court will notify any creditors with a floating claim on the assets of the corporation. Any such creditors can appoint an administrative receiver and thus bring the application for administration to a premature end. This veto is a powerful tool and results in substantially reduced administration orders.120 While the amendments to the U.K. insolvency regime were aimed in part at 'employees, the commercial economy and the general public,' the reality is that the current regime, which allows a single creditor to commence enforcement proceedings, creates a situation in which these broader interests are not really considered.121 The attempt to facilitate restructuring continues to be undertaken in a debt-collection paradigm. Moreover, the lack of clear codification for priority financing during the workout is a further bar to a successful restructuring regime.122 This may be the result of different policy instruments, such as the existence of the national insurance scheme for protection of workers. However, workers and other stakeholders do not appear to have any participation and decision rights, other than those possessed by virtue of their narrow fixed capital claims in the new workout scheme.

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Andrew Keay has suggested that the courts could give more consideration to the public interest in determinations under existing insolvency legislation. After considering the interests of the debtor and the creditors, the courts might then determine whether any public interest factor is relevant, and whether the public interest identified was more important than the interests of the debtor and creditors.123 Interestingly, the U.K. cases that have utilized the notion of public interest appear to have done so to refuse to endorse a rehabilitation plan because allowing a company to continue in the market place and accumulate further debt would be a grave risk to the individuals with whom the company deals.124 Keay suggests that community interest as a factor would not a priori take precedence over the interests of the debtor and creditors, but the nature of insolvency law implies that the courts have a role in considering community or public interest on a case-by-case basis. This approach reflects some of the scholarship of U.S. rehabilitation theorists. Keay argues that for the purposes of insolvency law, 'public interest involves taking into account interests which society has regard for and which are wider than the interests of those parties directly involved in any given insolvency situation.'125 He observes that the courts currently engage in a balancing of interests, and that the complexity of interests implicated in insolvency should not be a barrier to consideration of the public interest. Further amendments to the U.K. regime have recently been enacted, aimed at rescuing insolvent companies where there is a viable business plan. The Insolvency Act 2000 came into force 1 January 2003, including a series of new regulations and orders.126 A new Company Voluntary Arrangement Moratorium Procedure (creating a temporary stay or, in Scotland, a 'sist') offers small, financially distressed companies an enhanced chance for survival. The Act also makes technical improvements in existing arrangement procedures; amends the rules to allow for priority charges for insolvency professionals; and facilitates giving effect to the UNCITRAL model law on cross-border insolvency. The debate regarding whether the United Kingdom has sufficiently moved towards balancing liquidation and rehabilitation is far from over. In March 2002, the U.K. government introduced a new Enterprise Act, aimed at substantially reforming corporate insolvency by encouraging the rescue of viable businesses.127 The bill's introduction indicated that the current statute had not been effective in encouraging workouts and preventing premature liquidations. Failure to create a viable workout instrument means that when a firm is liquidated,

266 Creditor Rights and the Public Interest

there may be value left on the table that has not been extracted. The new Act received Royal Assent on 7 November 2002 and mandates that the administrator is to first 'attempt to rescue the company in its entirety/128 It prohibits the right of senior creditors to appoint an administrative receiver, subject to specified conditions. It streamlines the administration procedure by allowing secured creditors to petition for administration out of court; abolishes Crown preferences on taxes owed in order to increase the pool of funds available to unsecured creditors; and modernizes the financial regime of the administrative function.129 Essentially, secured creditors with floating charges are no longer able to unilaterally appoint an administrative receiver and thus pre-empt efforts at devising a restructuring plan. The procedure creates a more collective process, promoting duties owed to all creditors. The number of administrations may increase substantially in the absence of the senior creditors' veto, and the Act may create a streamlined administrative process aimed more clearly at rehabilitation. U.K. insolvency law, despite being creditor-oriented, has recognized the need for a stronger rescue mechanism to prevent premature liquidation. For Germany and the United Kingdom, as well as France and other EU nations, the most recent challenge will be posed by the European Bankruptcy Regulation that became effective in May 2002.13° While the mandatory regulation will not require any harmonization of domestic insolvency laws, it will have an impact on collective insolvency proceedings. The regulation will not affect administrative receiverships in the United Kingdom, although, as noted above, the Enterprise Act affords a streamlined collective workout process that falls under the EU Regulation.131 A cross-border EU proceeding would be allotted a centre of main interest, a defined term, and proceedings in all other jurisdictions would become secondary proceedings, with the courts of each jurisdiction recognizing the foreign proceedings. The regulation contains provisions to prevent forum shopping in EU member states. However, the debtor corporation, its employees, or creditors may request the opening of an insolvency proceeding on the basis that there are advantages associated with the law of a particular state. Jean-Luc Vallens has suggested that in this respect, the protections for employees are more extensive.132 The effect of the new regulation is likely to be increased cooperation and more effective dissemination of information, coordination of concurrent proceedings, greater ease of enforcement of foreign judgments, and enhanced monitoring of conduct of corporate officers during insolvency. Although credit-oriented and

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debtor-oriented regimes retain their domestic insolvency law regimes, and thus their particular preferences for liquidation or rehabilitation, the cross-border nature of insolvency and the new regulation are likely to create some convergence. It is far too soon to speculate whether these developments will promote or inhibit some of the ideas explored in this book. Conclusion It is evident that much more comparative study needs to be undertaken in order to fully understand how different insolvency regimes have attempted to take account of the diverse interests at risk when corporations are insolvent. The differences in economic and legal regimes in and outside of insolvency clearly influence policy objectives and instruments. Where a regime indicates some deficiencies in effective restructuring mechanisms, we must remember to situate that scheme in the overall regime for protection and recognition of debt, equity, and other interests, and in the context of complementary policy instruments to protect workers and others. We can, however, observe that while each of the regimes discussed above is moving towards a greater balancing of interests, the means by which they have chosen to accomplish this goal vary considerably. The current U.S. regime fails to effectively balance creditors' rights with those of the equity holders. This is not necessarily a product of its rehabilitation goals, but rather of the instruments chosen. The proceedings are time consuming, involve costly legal processes to determine value, and grant a relatively unfettered ability to officers of a DIP estate to delay decision making regarding a reorganization plan. While the courts have relied on notions of public interest, workers, consumers groups, and other stakeholders are largely absent from the process to design a plan. Where workers' rights have been statutorily protected, such as under section 1113 of the U.S. Bankruptcy Code, these rights have proven inadequate to protect workers' interests, as workers are plagued with some of the same problems faced by traditional creditors. France's model embraces the public policy objective of rehabilitation, while the accompanying policy objectives of protection of workers, economic recovery, and satisfaction of creditors' claims serve to ensure a more textured decision-making process in the workout. The scheme's policy instruments of early and preventive intervention pro-

268 Creditor Rights and the Public Interest

tect and enhance creditors' investments, including those of non-traditional creditors. France offers the best comparative model for recognition of workers' equitable investments in the firm. While other jurisdictions formally recognize the public interest in job preservation, they do not appear to make constructive use of workers' informational and organizational capital in decision making. The notion of community or other stakeholder participation is almost non-existent elsewhere, with the possible exception of the recognition of the decision rights of tort claimants in the United States. Only France has expressly embraced the idea of enterprise wealth maximization, although recent American case law indicates a slight potential for movement in this direction. Finally, in assessing the debt collection jurisdictions, two observations can be made. First, while both the United Kingdom and Germany continue to maintain their creditor-oriented approach, they have both recognized the need to provide for some opportunity for the debtor corporation to try to work out a viable plan. The underlying policy rationale differs from rehabilitation regimes in that the objective is to further enhance creditors' interests by avoiding premature liquidations. The fixed claims of employees as creditors, their human capital investments, and the interests of constituent members of the community may also benefit to some extent from the avoidance of premature liquidation. The new EU Bankruptcy Regulation is likely to have an impact on these issues, because of the growing need for effective cross-border mechanisms to address a firm's financial distress. While close convergence is unlikely, states continue to try to find the optimal combination of liquidation and rehabilitation policy instruments that meet their particular, debtor-oriented or creditor-oriented normative insolvency law objectives.

10 Conclusion: Future Development of the Public Interest within the Enterprise Wealth Maximization Model

In Canada, legislative debates and judicial interpretation have suggested that there is an element of public interest in the outcome of restructuring proceedings. I have suggested that 'public interest' is a short form for the complex balancing of interests that the courts engage in when determining whether to sanction a plan of arrangement or compromise for an insolvent corporation. The enterprise wealth maximization model suggested in this book enables us to better understand the current trends in judicial thinking and provides a rationale for further development. The framework's key elements - recognizing the value of a workout regime; recognizing the investments of creditors, workers, and other stakeholders; according participation and decision rights; and the substantive goal of enterprise wealth maximization - can serve as policy objectives and instruments as the law develops. The framework described in chapter 3 also provides a benchmark against which to measure concerns raised by debt collection, rehabilitation, and enterprise theorists. While these theoretical approaches conflict in some aspects of their analysis, their best elements can be utilized to develop the enterprise wealth maximization model. From debt collection theory, I have drawn on the need for an effective debt collection process; prevention of a race to realization; the need for consistency in and out of bankruptcy in how claims are valued; and the need to respect the hierarchy of credit in securities, corporate, personal property, and bankruptcy regimes. While the framework proposed endorses debt collection norms that insolvency law should be

270 Conclusion

indifferent as to whether liquidation or restructuring is the proper outcome in a particular case, it suggests that until all costs of the firm's financial distress are accounted for, and until investors with a current and future stake in the corporation are given an opportunity to participate in the assessment of options, there cannot be a full appreciation of which outcome is optimal. From enterprise theory, the model advocated in this book draws upon the recognition of multiple inputs into the firm's generation of surplus value, including equity, debt, and human capital investments. It suggests according value to the current inputs that generate wealth for the corporation, and which are not now properly accounted for in valuing firms. In addition, there must be a more systematic means of determining the difference between externalities and costs that should properly form part of the restructuring decision. The model suggested here takes the enterprise theory one step further by proposing principles that could be utilized in formulating a measure of the value of these inputs, which might then give rise to decision and participation rights. Valuation of such claims does not interfere with the current priority of secured claims, and given the current hierarchy, whether the outcome is liquidation, restructuring, or some combination of both, the claims of creditors are preserved, with value accounted for more realistically. However, the model does provide a basis for establishing the proportional share of the upside value of the restructuring that should accrue to workers and other non-traditional creditors, and it suggests that this determination should form part of the court's consideration in its sanctioning of a plan. From rehabilitation theory, the model draws on ideas about how to measure the community or public interest. While such interest may not involve capital claims on the corporation, the court's decision making may in some instances be enhanced by hearing the views of those elements of the community who have a direct nexus with the financially troubled corporation. A number of options, including participation rights in the insolvency proceeding, representation on restructuring committees, or input as amicus curiae have been put forward as means by which non-traditional stakeholders may be given a voice. Finally, both rehabilitation and enterprise theory assist in making the links between the interests of stakeholders implicated in the corporation's insolvency and restructuring and public interest concerns in protecting the environment and granting remedies against wrongful conduct. These issues are interwoven in the fabric of Canadian economic life.

Conclusion 271 Developing Notions of Enterprise Wealth Maximization I have suggested that enterprise wealth maximization, rather than shareholder wealth maximization or creditor wealth maximization, should be made a substantive objective of insolvency law. Such a recasting of goals would promote a governance model that accounts for all the inputs into the corporation. Its distributive consequence would be to recognize value currently generated by particular stakeholders, not only in capital investments, but in the governance role of debt and the contributions of human capital and infrastructure. Wealth creation would be linked more directly to those who have the greatest incentive to generate value and to monitor decision makers in governance of a corporation. Enterprise wealth maximization as a normative objective would address the concerns of debt collection theorists that creating differing rights in and outside of bankruptcy will lead to forum shopping. Inherent in the enterprise value maximization goal is a recasting of fiduciary obligation to take account of all interests in the firm. Earlier chapters suggested a governance model of enterprise wealth maximization with fiduciary obligation recast as 'best interests of the corporation, having regard to equity, debt and equitable investments.' Where the solvent corporation is concerned, this shift will likely engender considerable debate. On insolvency, however, Canadian courts have recently recognized that the directors' duty to a corporation as a whole extends to not prejudicing the interests of creditors in an insolvency context.1 This is particularly the case where the corporation was insolvent at the point at which a particular transaction was entered into, or where the transaction itself resulted in the insolvency. This reconception of fiduciary duty on insolvency erodes the shareholder wealth maximization model of corporate law and provides support for a model in which other stakeholders' interests can legitimately be the subject of the directors' legal duties. Judicial recognition of a shift in fiduciary obligation on insolvency is a relatively recent development in Canadian law. In Peoples Department Stores Inc. v. Wise, the Quebec Superior Court held that where a company is insolvent or near to insolvency, the directors' duties shift to a consideration of the interests of creditors when acting in the best interests of the corporation.2 The court held that where a corporation is approaching insolvency, only the creditors have a meaningful stake in its assets, and the directors therefore had an obligation not to sacrifice creditors' interests when the financial situation of the corporation

272

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was doubtful. The lower court's reasoning has been endorsed by several other courts.3 As this book goes to press, the Quebec Court of Appeal, nine months after hearing the appeal, rendered its decision in Peoples Department Stores v. Wise* The Court of Appeal allowed the appeal on a number of grounds. Most significant for the discussion in this book is the court's equation of the fiduciary duty of directors to the corporation with a duty owed solely to shareholders, equating best interests of the corporation as purely shareholder interests. The court held that, even on insolvency, the fiduciary obligation is still owed only to shareholders and that any extension of fiduciary obligation to creditors was a matter for legislative amendment. The decision appears to discount the fact that when the corporation is insolvent, shareholders' equity interests have little or no economic claim on the corporation's assets. Rather, it is the creditors that are entitled to a proportional share of the value of assets where the firm is bankrupt. Failing to recognize that directors and officers are to act in the best interests of the corporation, which in insolvency means having regard to the interests of all those with investments in the firm, including creditors and employees, unnecessarily narrows the existing statutory language. The court's analysis of the potential for duties to be owed to creditors on insolvency reflects a very civilian approach that is reluctant to import any specific obligations without express language regarding creditors. However, it appears to abandon this approach in finding that the fiduciary duty, which the statute expressly requires be rendered to the 'corporation/ is in fact owed to shareholders alone. The judgment appears contrary to recent decisions of Canadian courts in insolvency cases, as discussed in chapter 4. The judgment may also create enormous ex ante incentives for directors to act in a manner that depletes corporate assets and prejudices the interests of creditors and other stakeholders.5 The court also narrowed considerably its view of the scope of the duty of care in the CBCA, ignoring much of the case law concerning this duty in the past two decades.6 By importing notions of good faith, motivation, and reliance without requiring a basic due diligence standard before such defences are available, the judgment appears to largely disregard the statutory language. Leave to appeal is being sought to the Supreme Court of Canada, and hopefully, the Supreme Court will take the opportunity to provide some clear direction concerning this important issue. By comparison with other jurisdictions, Canadian law lags behind in development of fiduciary obligation during insolvency.7 Courts in

Conclusion 273

the United Kingdom, Australia, and the United States have long recognized that directors must consider the interests of creditors when the corporation is insolvent, although there are differences in opinion as to when that obligation arises.8 The slower development of these notions of fiduciary obligation in Canada may be explained in part by the availability of the oppression remedy under applicable corporate law statutes, which in some cases provides an alternative to recognition of creditor interests on insolvency. Oppression remedy provisions specify a 'statutory lifting of the corporate veil' where the conduct of directors is oppressive, unfairly prejudicial to, or unfairly disregards the interests of particular stakeholders.9 The courts have recognized that creditors and trustees in bankruptcy can be proper persons to bring oppression claims.10 The remedy, however, is available only in limited circumstances, and the courts will not allow debt actions to be routinely turned into oppression actions. Unfair prejudice encompasses the protection of the underlying expectation of the creditor in its arrangement with the corporation, the extent to which the acts complained of were unforeseeable or the creditor could reasonably have protected itself from such acts, and the detriment to the interests of the creditor. The earlier discussion of Canadian Airlines makes it clear that the courts will consider allegations of oppression in CCAA proceedings through the lens of multiple stakeholders, where the impugned conduct may be a function of the workout, not oppressive actions. These shifts in fiduciary obligation and more textured understanding of oppression remedies are key to consideration of the framework set out in this book. Enterprise wealth maximization is limited as an objective if parties do not have enforceable remedies. To recognize an expanded fiduciary obligation will not result in an expansion of unaccountable decision making by corporate officers because deference will continue to be paid to statutory hierarchies of credit and to business judgments. However, the shift will ensure that in a CCAA or other restructuring application, corporate decision makers will have incentives to consider the interests of all those with investments in the corporation, including those who can make claims against those decision makers under the expanded fiduciary obligation or oppression remedies. As discussed earlier, Algoma Steel represents a working model of an expanded notion of fiduciary duty in which directors and officers of the corporation have regard to equity, debt, and human capital invest-

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ments. The restructuring and economic turnaround of the corporation would not have been possible without the protection afforded under the CCAA, and without the skilled intervention of the court. Algoma Steel represents a major breakthrough in the courts' recognition of workers' interests and in the acceptance by creditors of the role that workers and their bargaining agents can play in the development of effective plans of arrangement. The experience of France's system of redressement illustrates that a clear articulation of multiple rehabilitation and debt collection goals, combined with structural intervention early in the firm's financial or economic distress, can lead to workout strategies that maximize enterprise value and reduce harms to various stakeholder groups. Developments in Canadian law in respect of creditor remedies are a move in this direction, but create delineation problems in terms of when fiduciary obligation shifts from shareholders to creditors. 'Best interests of the corporation' narrowly defined as shareholder wealth maximization and then equally narrowly shifted to secured creditor wealth maximization ignores the range of other interests and investments in the corporation at all stages of its economic life. While other international systems appear to lean too much towards rehabilitation or debt collection goals, causing either deferred liquidations or premature liquidation, the Canadian model offers potential for reconciliation of these tensions. Adoption of enterprise wealth maximization as a substantive goal permits a more comprehensive recognition of how wealth is generated in a firm and determination of who should benefit from its value. It also provides a means to create consistency in that goal in and outside of corporate insolvency. The Public Interest in Encouraging Restructuring Whether the normative goal of the insolvency regime is to facilitate debt collection, encourage rehabilitation, or some combination of the two, the public policy value of a workout regime has clearly been recognized. Canada's regime currently centres on debt collection, but the value of rehabilitative and enterprise wealth maximization goals is increasingly acknowledged. Developments in notions of the public interest reflect concern about the economic and social costs of firm failure. The shift has not been linear, however; rather, public policy has endorsed multiple goals for the insolvency law regime. The result has been successful restructuring of a number of insolvent corpora-

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tions over the past decade and the preservation and enhancement of value for multiple stakeholders. Where public interest is being argued, it is helpful to define the nature of that interest. It is equally important to quantify it where possible. While such information might not be readily available and there are costs associated with generating it, it is important that parties present their case to the court in economic terms. Evidence of the nature and value of the claim will assist the courts in determining the impact of its decisions and provide a clear basis on which negotiations for a workout should take place. In the absence of an economic valuation, 'public interest' becomes too nebulous and is easily dismissed, given the more compelling capital claims of traditional creditors within insolvency legislation. For example, in the Algoma Steel case, evidence was presented of the impact of corporate failure on the community. In Canadian Airlines, the liquidation analysis extended beyond direct capital claims to establish the social and economic consequences of the corporation's failure for employees, consumers, and local communities. In Red Cross, the court was faced with competing public interest claims: the direct claims of tort claimants relating to the serious harm to their health, the public interest in having a blood delivery system that the Canadian public could have confidence in, the public interest in retaining employees skilled in collection and delivery of blood projects, and the public interest in the continued humanitarian work of Red Cross. The court was assisted by having the value of those diverse claims placed before it, as well as information on how the workout would affect the various interests within the larger scheme of the economic and health care system. While ultimately the debtor corporation must devise a survival strategy acceptable to creditors, public policy recognition of the value of workouts creates the space and the forum for resolution of more specific claims. Public policy recognition of the value of workouts is situated in and complements a much larger scheme of economic and social activity and the corporate, securities, bankruptcy, and other public laws that regulate the corporation's activities. In recent years, environmental liability at the point of insolvency has become a key governance issue. This liability poses important challenges for the restructuring regime. Where restructuring efforts fail, environmental protection and clean-up costs are frequently borne by environmental authorities and, ultimately, by taxpayers. Often at the point of a CCAA proceeding, the outstanding environmental is-

276 Conclusion

sues that the corporation has been deferring for years come to the fore, and in many cases, particularly in the resource sector, there are millions of dollars in remediation liabilities. While there is a problem of inadequate enforcement of environmental standards when the corporation is solvent, which should be addressed much earlier in the firm's life cycle, environmental liability and remediation continues to be an immediate challenge in insolvency. One difficulty is determining who will bear responsibility for clean-up costs under environmental protection legislation. Liability runs with the land, and creditors, managers, and other stakeholders must necessarily consider the risks of environmental liability in considering whether or not to restructure. Environmental protection legislation has been strengthened considerably, imposing personal and corporate liability for environmental harm. However, environmental liability or tort claims arising out of environmental harm may be such that they impair the ability of the debtor corporation to pay its debts, thus precipitating insolvency or bankruptcy. Uncertainties about the extent of liability may hinder a corporation's ability to obtain further financing for restructuring, as the value of the security is uncertain.11 Decisions about converting debt to equity in a restructuring or exercising enhanced oversight are shaped by the environmental liability that creditors may be acquiring, particularly if there is the possibility of being named a 'person responsible' for the source of the contaminant. Environmental liability is also an important consideration in the court's determination of whether to approve a plan. Since these costs are often unknown at the point at which a debtor corporation is in CCAA proceedings, this can pose a barrier to successful resolution of the insolvency. Environmental issues are directly linked to the public policy objective of encouraging workouts where possible. If the corporation is liquidated, secured creditors have first call on almost all the value of the corporation's remaining assets and thus many remedial environmental costs are externalized to taxpayers and local communities. This has distributive effects in transferring wealth to senior creditors from the tax base. If the corporation continues and is in a position to generate further wealth, the environmental costs attributable to its prior activities are borne by the corporation, as opposed to the public generally. In order to reduce the distributive effects of environmental liability, both capital costs of remediation and long-term costs to quality of land, water, air, and human health must be appropriately valued in deciding on the future of the corporation.

Conclusion 277

Workouts facilitate the availability of financing for environmental maintenance or remediation by clarifying that creditors can conduct investigations or offer financing without acquiring the prior liability of the corporation. The availability of lender liability agreements with environmental authorities and, more recently, 'brownfields legislation' aimed at apportioning the risk and liability of revitalization of abandoned or contaminated lands during a workout, are positive public policy moves in recognition of the benefits of restructuring to environmental protection.12 In the 1992 Algoma Steel CCAA plan, the provincial government offered some protection for the operating lender as consideration for it extending a further bridge loan of $60 million; default would have granted possession rights without attracting any environmental liability.13 In Anvil Range, governmental stakeholders were instrumental, under the court's supervision, in creating a trust and working arrangement to ensure the corporation's environmental maintenance responsibilities were met pending development of a long-term plan. Amendments to bankruptcy legislation that have given priority to Crown claims for environmental clean-up costs over all other charges on the real property affected,14 and the ability of insolvency officers to abandon or release their interest in property,15 are aimed at encouraging creditors, through their officers, to consider taking steps to remedy environmental problems rather than abandoning the property. Since environmental costs are not considered administration costs, the costs of environmental remediation do not rank ahead of other claims in priority to any distribution to other parties of payouts of other assets, creating incentives for the Crown to negotiate going-concern solutions to environmental liability problems with creditors. There is strong public interest in ensuring that someone assumes responsibility for environmental protection at a time when the governance of the corporation is in disarray. This may result in a restructuring plan that includes a viable solution to the environmental problems that have been highlighted as the result of the insolvency, to the benefit of all stakeholders. Recognition of Stakeholder Interests This book has suggested that stakeholders such as workers, local governments, and trade suppliers frequently have investments and interests in a corporation beyond their fixed capital claims. These interests are not fully recognized in the current insolvency scheme. Tort claim-

278 Conclusion

ants such as those in the Red Cross case, while increasingly recognized as stakeholders with fixed, albeit contingent, capital claims, are also implicated in the workout by virtue of their specific claims and society's larger interest in creating incentives to prevent corporate harms. The allocation of decision and participation rights must recognize those who have investments at risk in the corporation, and who consequently have the incentive to develop a business and restructuring plan that will create efficiencies and added value for the corporation. The presence of workers, unions, local governments, and other stakeholders as parties to the court-supervised restructuring process is a vitally important development in this process. For tort claimants, the restructuring process may also provide a more cost-effective and expeditious resolution of their claims than civil litigation. The conceptual scheme for recognizing equitable investments in restructuring proceedings will not negatively impact the current preferred claim provided for workers' fixed capital claims in bankruptcy proceedings. Workers rank fourth in the statutory priority for creditors. On bankruptcy, however, the priority for their fixed claims is limited to claims for compensation owed by the debtor for the sixmonth period immediately preceding the bankruptcy, to a maximum of $2,000.16 Any claims for unpaid wages over and above that amount are unsecured claims. This wage preference has little value on liquidation, because often insufficient value remains after satisfying the claims of secured creditors.17 Debtor corporations and secured creditors have benefited from the inability of workers to bargain for a risk premium. Secured debt shifts bankruptcy-related risk from secured creditors towards workers whose preferred wage claims are subordinated to those interests; thus, as a policy instrument for the protection of workers' interests, this statutory preference has limited value. Arguably, according workers and tort claimants higher priority, or greater quantum in that priority, or creating national insurance or wage and training adjustment programs would correct many of the current and historical distributive effects of the insolvency regime. Debt collection theorists would suggest that this is properly the subject of legislation, and a question of ensuring that priorities and cost allocations are the same in and out of insolvency and bankruptcy. However, to date, suggestions that workers should receive some sort of 'super priority' in wage claims have not been able to garner political support. More systemic alternatives for protection of these interests, such as a national insurance scheme in which wage claims

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are paid up to a prescribed limit, as occurs in Germany and the United Kingdom, have likewise failed to garner support from secured creditors, who have been the principal lobbyists in Canadian insolvency law reform. In Ontario, wage protection legislation enacted in 1991 was repealed a few years later.18 In these circumstances, it is even more important that workers be afforded an opportunity to bargain what they can in the negotiations for a restructuring. Equally, however, it is timely with the 2003 federal government review of the B1A, to seriously consider the priority and amount of workers' wage and other claims, precisely because of the current inequitable distributive effects of the system. Workers who have lost their jobs or are at risk of these loses are the least able to politically lobby for such change and it is in the public interest to seriously consider how better to protect the most vulnerable claimants when the firm becomes financially distressed. The legislative review process should account for those individuals that do not have the information or resources to have their voices heard. Moreover, enhanced priority of claims in bankruptcy would create ex ante incentives for corporate officers, as well as senior creditors monitoring the firm, to ensure that these claims are met prior to bankruptcy, in turn reducing harms to these investors. Similarly, it is timely to consider the costs and public policy implications of a national insurance system that would more appropriately allocate bankruptcy-related risk and offer greater protection to workers. This should be considered in conjunction with enhanced priorities. Both create incentives to pay workers' wages in a timely manner, to prevent preferred bankruptcy claims, and to control costs of an experience-rated or similar national insurance system. These more systemic remedies to insolvency harms deserve serious study and action. There are numerous models internationally that would facilitate a cost/benefit analysis of these remedies, including empirical study of the impact on credit availability, the upside benefits to the Canadian economy, and the synergistic effect of multiple strategies to allocate bankruptcy risk. These systemic remedies are complementary instruments to the restructuring regime suggested in this book. They would also create greater incentives to recognize workers' interests during negotiations for a workout. The CCAA affords both the courts and the parties before them the greatest flexibility in recognizing the diverse interests of all those who have made equity, debt, and equitable investments in a corporation. Decision making should be undertaken with a view to enterprise wealth

280 Conclusion

maximization, having regard to all interests and investments at stake. This should include all traditional creditors, workers, local governments, and others who have not only fixed capital claims but also equitable claims on the insolvent firm. The framework suggests that on firm failure, workers and other stakeholders, depending on the circumstances, should have the right as equitable claimants to participate in negotiations and decisions in the development of a viable plan of compromise or arrangement. This role should be given substantive recognition, notwithstanding the fact that the capital claims of workers and other creditors are often very small compared to the claims of secured creditors. Often with firm failure, there is untapped informational, organizational, and other human capital that could promote the development of a sound business plan and an enhanced governance structure. Arguably, there is also a broad range of other stakeholders, such as local communities or consumer groups, who, in particular situations, have interests at risk in the corporation. While the nature of these claims may be more difficult to quantify, this difficulty should not act as a bar to the participation of such stakeholders in the process, if the aim is to develop a restructuring plan that fairly allocates the risks and potential benefits of a financial turnaround of the corporation's economic situation. The court has the discretion to accord intervenor status even where there are no fixed capital claims. Granting such status would ensure that equitable interests are expressed to the court so that it in turn can undertake an effective balancing of interests. However, changes to recognize equitable investments must ensure that these newly acknowledged interests are properly balanced against those of secured lenders and other traditional creditors. The recognition of both a procedural and substantive role for social stakeholders in the Anvil Range case represents an important step in the evolution of judicial thinking. The court recognized stakeholder interests beyond the very narrow paradigm of traditional creditors and shareholders. Those interests are both social and economic, although they may not be exclusively fixed capital claims. Similarly, while thousands of trade creditors and workers were not 'affected creditors' within the Canadian Airlines plan of arrangement, their interests were considered by the court in determining whether to approve the plan and a factor in its determination of the oppression allegations. Some practical lessons for stakeholder groups seeking to participate for the first time in CCAA proceedings arise out of both the frame-

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work proposed and the cases studied. First, in seeking standing, it is essential to identify the nature of the claim or interest in the proceedings. The nature of the interest may be one or more of the following: an interest traditionally recognized by the court (fixed claims for wages or unpaid claims for trade suppliers); the type of interest more recently recognized by the court (tort claims); or an interest with potential for future recognition by the courts (the equitable investments made in a corporation by workers, local governments, small trade suppliers, or others). As suggested throughout this book, the nature of the interest will often include both fixed capital and equitable claims. Where the stakeholders have fixed claims, those claims may ensure that they are participants. They must then assert their equitable claims. The support of insolvency counsel may be crucial to a successful meshing of consideration of non-traditional claims with existing priorities in insolvency. Second, the stakeholder seeking participation rights must frame any request for access to the proceeding in terms recognized by the court or in such a way as to persuade the court to consider granting such rights. In a case where the fixed claims of workers are satisfied early in the process, their equitable claims continue to exist. Similarly, a consumers' group or community organization with a particular nexus of interest in the corporation's activities may not have any fixed capital claims. In these cases it may be possible to use the criteria for intervenor status under such court processes as the Rules of Civil Procedure to successfully argue that the court should grant participation rights on the basis that their equitable investments are affected by the decision making concerning the future of the firm. A number of devices could be deployed to enhance access to the workout process. While these could usefully be enshrined in legislation, it is worth emphasizing that the courts currently have discretion to consider them. While some devices have been deployed in particular cases, as indicated, there is not yet a consistent pattern such that multiple stakeholders can be confident of their participatory rights. Devices already recognized and utilized by the courts are indicated by the case name references in brackets at the end of the description. RIGHT TO RECEIVE NOTICE

• Notice should be granted as of right on initial filing of CCAA applications to identifiable stakeholders. The granting of ex parte initial stays should be restricted to urgent situations, as they are now, with limited periods for parties to come back on notice; but

282 Conclusion

granting the stay should be made on the condition that the debtor is required to give notice to employees, their unions, local suppliers, governments, and any known tort claimants. • Notice of CCAA proceedings and initial stay orders should be accessible in terms of language and should not unduly overreach in terms of issues addressed in advance of stakeholder consideration of those issues. (Royal Oak Mines) • Use should be made of available methods of communication (e-mail, internet) and established relationships (unions) in order to give notice and to disseminate information, enhancing access to information and informed decision making. (Algoma Steel, Red Cross) • Court orders should be sought to ensure that broader notice is given to stakeholders, both of initial filings under the CCAA and any subsequent motions or proceedings. DISCLOSURE

• The current system of extensive disclosure needs to be reformed so that all interested stakeholders, and not merely the senior creditors, have access to the public records regarding the firm's financial distress. • Information rooms and telephone hot lines should be established, and internet websites utilized in order to reach broad numbers of stakeholders, to reduce information asymmetries, and to lower transaction costs in the proceedings. (Red Cross, Algoma Steel) ENHANCED PARTICIPATION RIGHTS

• The court should consider stakeholder requests for representative participation on a creditors' committee or any restructuring committee struck to advise the monitor or the debtor on the terms of a possible restructuring. (Red Cross) • Worker representation at CCAA proceedings must be ensured, either through the union or, where the workplace is not unionized, by appointment of worker representatives. (Anvil Range Mining Corporation, Algoma Steel, Canadian Airlines, Red Cross) • Appointments of representative counsel for workers, small trade suppliers, or tort claimants should be requested. (Red Cross, Eaton's) • Funding for representation and/or participation on the creditors' committee on a priority basis should be provided out of the assets of the corporation, pension money in escrow, or, where appropriate, by the government. (Eaton's, Red Cross, Algoma Steel)

Conclusion 283

• Class proceedings legislation may be used to seek appointment of representative counsel. (Red Cross) • Amicus curiae status can be granted to community stakeholders where parties before the court do not represent the particular environmental, consumer, social, or economic interests that should form part of the court's consideration of any proposed plan of arrangement or compromise. • A variety of dispute resolution and interest-based mediation techniques may be utilized to ensure that those with both fixed capital and equitable interests can contribute their views on the reasons for the firm's financial distress and suggest potential goingforward strategies for generation of future value. (Algoma Steel, Red Cross, Anvil Range) ENHANCED DECISION RIGHTS

• Access to negotiation and mediation in terms of resolving specific disputes and crafting a plan should be provided, together with the resources necessary to ensure that stakeholders are not disadvantaged by the power imbalances inherent in such processes. The role of the court in both mediating and in ensuring rights are not compromised contrary to law is key to this. (Red Cross, Algoma Steel) • Definition of classes of creditors that more fully accounts for the nature of their interest in the firm should be created. • Workers should be defined as a separate class of creditors, given the unique nature of their human capital investments. • Claims for fixed capital and equitable claims should be quantified for purposes of voting on the CCAA, thus putting information regarding the consequences of particular insolvency outcomes before the court. • Motions may be brought, where appropriate in the context of the CCAA proceedings, to deal with any breaches of fiduciary duty or oppressive conduct. (Canadian Airlines) • Creative use of voting - one tort claimant, one vote - should be considered where the quantum of claims may be difficult to assess in a timely manner, thus enhancing the possibility for an expeditious going-concern solution. (Red Cross) Some or all of these strategies may be appropriate in a particular insolvency case. As noted earlier, the challenge is to craft practical, cost-effective means of ensuring these voices and interests are accounted

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for when deciding the firm's future. Traditional creditors have for many years received financial assistance from the estate of the insolvent corporation to permit their participation in the restructuring discussions, including representation on creditors' committees. More recently, the use of representative counsel has occurred where the debtor corporation believes that it is in its interests to handle diverse or complicated claims in this manner. Stakeholders who seek participation rights may be able to successfully argue to the court that effective exercise of those rights is contingent on receiving funding for representative counsel. Some of the procedures suggested are in a nascent stage of development; others could be considered by the courts and parties in future restructuring applications. As yet, there are no reliable enforcement mechanisms, although development of a more expansive fiduciary duty for financially troubled corporations, as well as the availability of the oppression remedy for actions during the restructuring proceedings, may provide a degree of enforcement capacity for nontraditional creditors. Reconciling Interests of Public Interest Stakeholders with Those of Traditional Creditors Ultimately, insolvency and bankruptcy is a creditor-driven regime. Creditors have statutory and contractual rights to realize on their claims if the debtor is unable to persuade them of the merits of a proposed restructuring plan. My intent in this book has been to suggest principles for the reconciliation of traditional creditors' rights with a judicial recognition of the 'public interest' in the restructuring of the insolvent corporation. As argued throughout, the optimal outcome of a restructuring process may be rehabilitation, liquidation, or some mix of restructuring and sale of all or part of the business assets. However, in deciding on the appropriate action there ought to be express recognition of the interests at stake and a role accorded to those interests in the decision-making process. The CCAA is the key legislative vehicle through which reconciliation of stakeholder rights can occur, with the courts performing an important facilitative and supervisory role in the process. The availability of specialized expertise and a strong commitment to expeditious and effective case management have resulted in highly successful restructurings and the evolution of the notion of 'public interest' as an important part of the equation.

Conclusion 285

As the discussion in this book has illustrated, the interests of workers, tort claimants, local governments, and others often converge with those of more traditional creditors. It is important to identify this convergence of interest if there is to be a successful workout for the corporation. Part of this determination requires a more textured understanding of where the costs lie, including the costs of firm failure and the transaction costs associated with enhanced participation rights and greater buy-in of the ultimate restructuring plan. Establishing a convergence of interests may contribute to the development of a goingforward strategy in the restructuring debate. Cross-Border Insolvency Proceedings and Implications for the Public Interest Multinational enterprises are generally engaged in global governance in terms of both decisions about resource allocation and going-concern business decisions. Yet when a multinational corporation approaches insolvency, its global management disappears, and with it the ability to make timely decisions. The corporation must deal with different creditors and different priorities in different statutory schemes, and thus the usual conflicts between stakeholders are exacerbated by conflict of law issues. This trend is likely to continue, given the strong interest that states have in protecting their domestic insolvency regimes. However, the increase in cross-border insolvencies gives rise to new issues and has direct implications for the development of an enterprise wealth maximization model. In the past ten years, the courts have developed protocols on crossborder cooperation. The cases involved Canadian debtor corporations with significant operations and asset holdings in the United States, or vice versa, and thus the debtor corporations required recourse to protection of insolvency laws in both jurisdictions. The orders addressed coordination and cooperation in the administration of the proceedings, coordination in ongoing operations, asset sales and distribution, claims filing procedures, and choice of law issues; and coordination of development of plans in both countries. These protocols have reduced the cost of litigation and placed the focus on restructuring issues instead of conflict of laws disputes. A protocol sets out the ground rules by which concurrent insolvency proceedings can be coordinated. These include honouring the sovereignty of the respective courts; harmoniz-

286 Conclusion

ing activities in multijurisdictional insolvency proceedings; promoting the orderly and efficient administration of proceedings; promoting international cooperation and respect for comity among the courts; facilitating fair and open processes for insolvency proceedings for the benefit of all parties; and implementing a framework of general principles to address basic administration issues arising out of cross-border insolvencies. More recently joint hearings have been conducted by Canadian and U.S. courts in restructuring applications.19 Such hearings allow parties on both sides of the border the benefit of making submissions and hearing concerns of the court without the 'filter' of reading their views in foreign judgments. Courts can signal parties regarding restructuring issues that concern the court's particular jurisdiction and the hearings allow judges to communicate directly rather than through written judgments. Given the time-sensitive nature of restructuring proceedings, joint hearings may expedite decisions, reduce the costs inherent in multiple court appearances, and facilitate decisions that have pragmatic and practical effect in both jurisdictions. To date, protocols for cross-border insolvencies have developed coherent procedural protections for proceedings in multiple jurisdictions. Substantive issues are at their nascent stage and the caselaw continues to be underdeveloped, conflicting on the issue of the level of deference to be accorded for proceedings. Some uncertainty is also created in respect of the treatment of foreign main proceedings and 'foreign nonmain proceedings.' While no cases dealing with the public interest directly have yet been brought, there are public interest implications. Chapter 9 briefly touched on the potential effects of the new EU bankruptcy regulation in Europe and internationally. The Canadian economy is heavily dependent on its trading relationship with the United States, as well as access to U.S. capital markets. There is also a heavily integrated parent-subsidiary relationship among the two nation's corporate structures. As a result, many Canadian cross-border proceedings involve U.S. corporations. The doctrine of comity has developed as a mean to enhance cooperation in insolvency proceedings that cross borders because of the globally integrated nature of corporate economic activity. The principle of comity permits the court to recognize and enforce in Canada the judicial acts of other jurisdictions.20 The doctrine of comity initially developed through the common law. For example, in Roberts v. Picture Butte Municipal Hospital, the court recognized the U.S. Chapter 11 proceedings of Dow Corning

Conclusion 287

and upheld the stay under those proceedings, finding that the appropriate forum to deal with the tort claims was the U.S. Bankruptcy Court.21 While the common law was developing in this respect, both the CCAA and the BIA were amended in 1997 to expressly empower the Canadian courts to make such orders and grant such relief as they consider appropriate to facilitate, approve, or implement arrangements that will result in a coordination of proceedings under the CCAA with any foreign proceedings.22 The U.S. Bankruptcy Code has similiar language under its section 304 ancillary proceedings section, designed to encourage U.S. courts to cooperate with foreign insolvency representatives. There continues, however, to be a tension between comity and the concern of domestic parties that their statutory rights not be eliminated in the interests of international cooperation. This tension has been exacerbated somewhat by uneven judicial application of the CCAA provisions. For example, the CCAA provision defining foreign proceeding does not contain an explicit provision requiring a foreign debtor to be insolvent. While the provisions are arguably aimed at recognizing the existence of cross-border concurrent proceedings, this lack of definition has given rise to some uncertainty in the court's application of the provision. For example, in Re Singer Sewing Machine, the Alberta court declined to enforce a stay under U.S. proceedings on the basis that the Canadian subsidiary company was a separate corporate entity and the creditors were only creditors of the Canadian subsidiary, not the parent U.S. corporation.23 In contrast, in Re Babcock and Wilcox, involving mass asbestos tort litigation, the court applied a U.S. stay order to a solvent Canadian subsidiary that was not part of the U.S. proceeding. The court did not address the implications of exercise of its authority for either stakeholders in Canada or the American tort claimants.24 Notwithstanding the fact that several courts have subsequently adopted the reasoning in Re Babcock and Wilcox, the judgment has been criticized for creating an uneven standard between enforcement of foreign proceedings under the BIA and the CCAA.25 Such a judgment prohibits foreign tort claimants from proceeding with claims against the solvent Canadian company, but it also acts as a stay on the claims of Canadian creditors in the interests of a foreign proceeding.26 Part of the difficulty is that in Canada, the debtor must be insolvent in order to file under the CCAA, whereas debtors do not need to be insolvent under Chapter 11 proceedings. Clearly, more consideration is needed of the impact of such reasoning on stakeholders in both jurisdictions.

288 Conclusion

More recently, the Supreme Court of Canada, in Holt Cargo Systems, held that different jurisdictions have a legitimate and concurrent interest in the conduct of international bankruptcy proceedings and that Canada has adopted a pluralist approach. Thus while Canadian courts should be mindful of the principles of comity, they must also do justice to the particular litigants before them.27 The court has the discretion to enforce or decline to enforce any order made by a foreign court and is expressly empowered to seek the aid and assistance of a foreign court or other authority where it considers such assistance appropriate. Canadian courts have recognized foreign orders on the basis of comity, where it is not in violation of public policy, although there is considerable debate about the level of deference that should be accorded to proceedings that do not directly implicate the assets of Canadian corporations.28 In Philip Services Corp., the court, in refusing to sanction a crossborder class action settlement in the context of a CCAA proceeding, held that the proposed settlement and the issue of whether the debtor corporation could be successfully restructured were closely linked.29 The fact that a Canadian creditor's rights are to be dealt with by parallel U.S. insolvency proceedings is not in itself sufficient to undermine the fairness and reasonableness of a restructuring plan. However, the right to vote on the plan before creditors are bound is an essential component of the CCAA regime. Comity does not mean that one court must cede its authority over its own process or over the application of substantive laws of its own jurisdiction; here, the issue was less an issue of comity than of a debtor corporation failing to comply with the statutory requirements of the CCAA.30 The onset of cross-border proceedings poses potential problems to the continued development of the recognition of the public interest recently articulated by Canadian courts in restructuring proceedings. The problems with the U.S. restructuring regime outlined in chapter 9, in particular, its singular emphasis on rehabilitation and simultaneous underdeveloped recognition of stakeholders with equitable investments in the firm, could lead to a narrowing of participation rights in crossborder proceedings where the Canadian component is significant. The highly codified U.S. regime, with its APR rule, 'cram-down/ DIP financing rules, and other restrictions, leaves less flexibility for the court to consider public interest stakeholders. Given that most cross-border cases to date have involved the United States, this may have a normative impact on how notions of public interest develop in cross-border restructurings, although equally, Canadian law could have a positive

Conclusion 289 normative effect on the U.S. regime, where the main proceeding is located in Canada. Canada is currently considering whether it should adopt the draft UNCITRAL Model Law for cross-border insolvencies.31 This would provide a more comprehensive basis for addressing recognition of foreign insolvency proceedings.32 Adoption could enhance current developments in recognition of stakeholder interests, because the Model Law specifies that the court, recognizing the foreign proceedings and status of the foreign representative, impose a stay where compatible with domestic law and restrain disposal of assets without consent. All stakeholders are to be treated equitably, regardless of the jurisdiction in which they reside, and the 'enterprise is to be permitted to implement a plan so as to reorganize as a global unity, especially where there is an established interdependence on a transnational basis/33 Thus while facilitating cross-border insolvencies the Model Law would also promote a level of deference to Canadian law and the court's developing jurisprudence in regard to the public interest. Where cross-border proceedings implicate jurisdictions with a more fulsome analysis of stakeholder interest, such as France, there is potential for further development of notions of enterprise wealth maximization, public interest concerns in workouts, and enhanced stakeholder participation rights. Consideration of the complexity of these issues is well beyond the scope of this book. However, it is evident that future important development in the courts' public interest model will derive from consideration of the tensions between principles of sovereignty and international comity, as an increasing number of crossborder cases come before the courts. Federal Legislative Review and the Implications for an Enterprise Wealth Maximization Model The federal government is currently engaged in a broad-based review of the BM and the CCAA as part of the statutorily mandated five-year review of the legislation.34 The policy implications are potentially enormous and could easily form the basis of a separate book. In terms of the enterprise wealth maximization model proposed in this book, however, several issues deserve to be highlighted: the issue of director and officer liability, DIP financing, and executory contracts. While developments in director and officer responsibilities, discussed earlier in this chapter, arguably enhance judicial consideration of the public interest by providing a benchmark against which the conduct

290 Conclusion

of corporate officers can be assessed in governance of the insolvent corporation, the federal government may move in the opposite direction. The federal government has announced that it will consider legislating the creation of national standards, and possibly a safe harbour from all director liability in the period leading up to or in insolvency. The codification of director liability during insolvency, assuming that it did not run into paramountcy problems, could create inconsistencies in standards for director liability in and outside of bankruptcy. As debt collection theorists have noted, the proposed change might encourage directors of financially troubled corporations to move into the bankruptcy scheme prematurely to avoid liability under provincial statutes. The 'safe harbour' policy option is offered as a potential efficiencyenhancing strategy that would serve to attract and retain directors who might otherwise not serve on boards of insolvent corporations, thus facilitating reorganizations. However, the policy addresses the 'rehabilitation' aspect of the regime without considering the debt collection aspects. Creditors are entitled to realize on their claims if the corporation does not devise a viable workout plan that meets the requisite support of creditors. The liability provisions are intended to ensure that those who are in the best position to see that statutory preferences and trust claims are met prior to the firm's distress, do so. This is distinguishable from breach of commercial contracts, which the corporation can breach in or outside of insolvency and which never attract personal liability, absent fraudulent misrepresentation or other tortious conduct. The safe harbour model, while it would encourage directors to remain throughout a workout process, has the effect of removing an important protection for one of the most vulnerable groups in insolvency: employees whose wages have not been paid. It is unclear whether any efficiency gains would outweigh the harm to these creditors or the agency costs involved in ensuring that directors do not use the protection to avoid responsibility for corporate decisions that have placed the interests of creditors at risk. Moreover, Ronald Davis has suggested that director liability for employee wages is actually efficiency enhancing, in that its bonding effects result in interactive governance and accountability that benefits all creditors.35 Before immunity is granted to directors, fuller consideration should be given to alternatives that do not give rise to incentives for ex ante shirking of obligations. For example, currently, many CCAA orders include indemnification for directors with a first charge on the assets,

Conclusion 291

as a means to limit their liability exposure and to encourage them to stay during the workout period. Unlike a universal safe harbour, the protection here is granted by the court under the supervised CCAA proceeding, where creditors have notice of the indemnification and can make representations. The ability of creditors to make representations to the court where such protection is not appropriate, due to the failure to consider the creditors' interests, provides the proper ex ante incentives to directors to discharge their duties diligently. Stakeholders such as employees, pensioners, and community members affected by environmental harms also have an opportunity to challenge the first charge and have the court make a determination as to the scope of liability protection. Rather than encouraging opportunistic behaviour, this method of balancing protection for vulnerable claimants and the need to encourage directors to serve will provide incentives for directors' diligence pre-insolvency and their continuation as directors postinsolvency. The debtor-in-possession financing issue, while one of liability, also raises questions regarding confidence in the governance structure of the corporation during CCAA proceedings, and whether creditors should have voice and control rights in the use of workout financing. The federal government is considering, for example, whether DIP financing should be available only for post-CCAA filings. At that point, the debtor corporation is under supervision of the court and the creditors have better access to information about the corporation's resources, such that an informed decision can be made about whether to grant the financing on a priority basis. The Insolvency Institute of Canada and the Canadian Association of Insolvency and Restructuring Professionals (IIC/CAIRP) have recommended that the legislation enshrine guidelines for the courts' exercise of its discretion to authorize a DIP loan. These might include consideration of the arrangements that have been made for the governance of the debtor corporation during the proceedings; the competence of managers, and creditors' confidence in them; the expected period to determine whether there is a goingconcern solution; whether the DIP loan will enhance the prospect for rehabilitation; the nature and value of the debtor corporation's assets; whether any creditors will be materially prejudiced; and whether the debtor has provided a detailed cash flow statement. These guidelines would be helpful, although arguably the court already takes account of these factors, as discussed in chapter 4. IIC/CAIRP also recommends codifying notice before DIP financing subordinates pre-exist-

292

Conclusion

ing credit. As discussed in chapter 4, notice is important in DIP financing decisions, because the court must weigh the prejudices in exercising this discretion and the parties affected should have the opportunity to be heard before the court makes this determination. Equally important is the recommendation that the court have authority to allocate the DIP costs on a just and equitable basis among creditors. This makes sense, given that it is creditors generally who receive the upside value generated by a successful restructuring. While to date the DIP financing issue has largely been cast as giving secured creditors a greater voice in governance decisions, the court in its supervisory capacity could consider multiple stakeholder concerns. While legislative guidance on DIP financing could be helpful, there is also a risk of providing secured creditors with another route for vetoing a restructuring process, where they unilaterally determine that they are not satisfied with the corporation's existing managers. Thus, in reviewing the means by which to achieve the appropriate balancing of facilitating restructuring and facilitating financing transactions, the government should be aware of the distributive effects of its policy choices. A number of pro-creditor organizations have endorsed the 'creative destructionism' of the present regime, that is, the view that businesses that are not viable should be allowed to fail to make way for new, 'more efficient' businesses. While it is indisputable that a viable business plan is an essential prerequisite to a workout, the discussion throughout this book reveals the distributive consequences inherent in moving the system back further along the pro-secured creditor continuum. The highly codified protection of creditors' rights in the United States arose as a compromise during periods in U.S. history in which legislators wanted to enhance the rehabilitation protection devices in bankruptcy law. To import some of these ideas into what is already a creditor-oriented regime has economic and social consequences that will mainly be borne by less senior creditors and other stakeholders implicated in the firm's financial distress. A lobbying effort seeking legislation that would allow debtors to unilaterally disclaim executory contracts has also been undertaken. An executory contract is one where both parties still have an obligation to perform. These can include distribution agreements, leases, technology licensing agreements, and employment contracts. While disclaiming such contracts benefits debtors, it also benefits secured creditors by enhancing the pool of assets in the debtor's estate. Many groups

Conclusion

293

lobbying for the ability of the debtor to disclaim executory contracts have carved out exceptions in their proposals for eligible financial contracts and other financing agreements, thus protecting their own interests. Maintenance of valuable contractual rights is often essential to a successful restructuring plan. The issue is really one of when the debtor corporation should be allowed to 'shed' contracts. While there may be some merit in such provisions for intellectual property and similar licences, which currently do not have an easy means of being resolved, the current lobbying effort also targets collective agreements. This creates enormous risks to workers within the creditor-oriented restructuring regime in Canada, risks made evident in the earlier discussion of section 1113 of the U.S. Bankruptcy Code. However, unlike the U.S. scheme, what is proposed here is the granting of a unilateral right by the debtor corporation to disclaim collective agreements on the monitor or trustee's approval, without the need for court approval and without any protective provisions for workers.36 A recent submission to the government suggests that the economic and social policy objectives of promoting going-concern solutions justifies interference with the contractual and legal rights of multiple parties, not just creditors, as long as those parties are not rendered worse off by a going-concern solution.37 While this suggestion appears intuitively supportable, given the need for all parties to make compromises in the interests of devising a going-forward strategy, it may actually discourage compromise by over-emphasizing the liquidation rights of secured creditors in relation to the public interest in enterprise value maximization. Liquidation focuses on the immediate realization of creditors' claims, while enterprise value maximization requires the creditors to assume some risk of deferred realization in return for the chance of an increased return in the future. The reality is that collective agreements and employment contracts reflect deferred compensation systems. At the point of insolvency, the debtor corporation has often already extracted its portion of the value from the collective agreement, leaving only the cost-side commitment, that is, protection of seniority rights and health and pension benefits. A unilateral right to disclaim such contracts will thus always be in the debtor corporation's interest. It fails to recognize the inherent special nature of employment contracts. The proposal for termination damages for disclaimed contracts would be an inadequate remedy, given the nature of workers' interests and investments in the firm. There are even proposals to allow portions of contracts that specify changes to

294 Conclusion

contractual provisions upon the commencement of an insolvency proceeding to become void, if they are materially adverse to the debtor's interests. Practically speaking, this could mean that where unions have negotiated special adjustments from harms of firm failure, the adjustments won could be declared void. The statutory change proposed would have enormous and harmful distributive effects on workers and their human capital investments. Moreover, it is likely to give rise to ex ante negotiation costs, as unions will start to require costing and undertakings as to the value of particular provisions so that they have quantifiable damages if the firm later experiences financial failure. Aside from the obvious information asymmetries and bargaining power inequalities created, such a move would increase transaction costs both in and outside of insolvency. Moreover, as illustrated in the discussion of the U.S. bankruptcy model, special protections for collective agreements have proven to seriously disadvantage workers' interests because of the narrow interpretation given them by the courts. The federal legislative review should consider more systemic approaches to insolvency law reform. It is worth observing that the current review is largely being shaped by secured creditors and their agents. Without in any way detracting from the importance of their concerns or from the public interest in the continued availability of cost-effective credit, there is a serious risk that these concerns will be addressed to the exclusion of other interests. Public choice theory suggests that legislators are more receptive to pressure from well-organized special interest groups that are repeat players in the system, offer a sophisticated analysis of their position, and are well-funded to champion their cause. Most of the stakeholders likely to be affected by future corporate insolvency are either unaware that they will be affected and unfamiliar with the current scheme and its distributive consequences, or lack the resources, information, or energy to lobby for legislative change. Legislators must ensure that legislative reform does not merely reflect the interests of those best equipped to lobby for change. It is incumbent on legislators, in their public policy mandate, to explore the more systemic approaches advocated in this book, including mandatory notice and participation rights for all those with a direct economic interest in the corporation; consideration of an express statutory objective of enterprise wealth maximization; development of national insurance, wage adjustment, and training programs; consideration of super-priority for wages and other specified claims;

Conclusion 295

and perhaps even measures that impose higher obligations on secured creditors to negotiate in good faith before they are allowed to exit the workout process and realize on their claims. These are important policy initiatives that deserve serious consideration as the review moves forward. Conclusion Recognition and valuing of workers' and other corporate stakeholders' equitable investments may allow for protection beyond insolvency, in situations such as mergers, acquisitions, hostile takeovers, and the restructuring of solvent corporations. The validity of applying the framework suggested in this book to such situations is clearly an appropriate area of future study. In the interim, the framework stands effectively on its own in terms of its application to the restructuring of insolvent corporations. The legitimacy of government intervention in the market, including the employment market, is increasingly being challenged. Governments have responded to these challenges by engaging in a withdrawal from or dramatic lessening of protections for workers in the employment relationship, including their human capital investments. With the choice of public policy instruments shrinking as governments continue to devolve their protective functions onto the market, an increased emphasis on recognizing workers' interests in the corporate governance and insolvency regimes can provide some (but not all) of the protection of workers' investment formerly provided by remedial legislation. Corporate and insolvency law cannot provide an effective substitute for remedial employment and labour legislation. However, as a policy instrument, insolvency law is part of a much larger scheme that needs to recognize and protect the investments of workers, creditors, and stakeholders while encouraging economic activity. As noted, government intervention and national wage protection and retraining schemes may be the optimal means of protecting workers' human capital investments. Consumer protection legislation or national insurance schemes may likewise play a role in protecting the reliance and expectation interests of consumers, communities, and other equitable investors. However, the existence or absence of such protection does not detract from the exercise engaged in here. The ideas presented in this book are intended to complement rather than replace

296 Conclusion

the range of policy instruments available to accomplish these objectives. Insolvency law can co-exist with other protective schemes in a more productive and effective way by recognizing more explicitly the public's interest in insolvency and the equitable investments of the range of stakeholders with interests in the insolvent firm.

Notes

INTRODUCTION

1 Algoma Steel Corporation, Court File No. B62191-A (Ont. Ct (Gen. Div.)). 2 Re White Rose, Endorsement (27 Nov. 1998) Ontario Court File No. 98 CL 3178 (Ont. Ct J. (Gen. Div)). 3 Edward Sellers et al., 'Governance of the Financially Distressed Corporation: New Challenges for Refinancing in Global Capital Markets/ in J. Sarra, ed., Corporate Governance in Global Capital Markets (Vancouver: UBC Press, 2003). 4 Jeffrey Gordon, The Shaping Force of Corporate Law in the New Economic Order' (1997) 31 University of Richmond Law Review 1473 at 1478; Adrian Wood, 'How Trade Hurt Skilled Workers' (1995) Journal of Economic Perspectives 57. 5 William Mills, 'The Shape of the Universe: The Impact of Opinions on the Process of Legal Research' (2003, forthcoming, New York Law School Law Review). 6 Marjorie Girth, 'Rethinking Fairness in Bankruptcy Proceedings' (1999) American Bankruptcy Law Journal 449 at 463. 7 Vince Siciliano, 'Trustee's Role: From Petition to Discharge' (Toronto: Canadian Bar Association Conference on Insolvency and Bankruptcy, Unpublished paper, on file with Canadian Bar Association, 1996) at 23. 1 The Existing Regime for Restructuring Insolvent Corporations 1 Karen Gross, Failure and Forgiveness: Rebalancing the Bankruptcy System (New Haven: Yale University Press, 1997) at 249.

298 Notes to pages 10-14 2 'Creditors and workers together can fix the bench to enhance its value.' Translation into Italian: Sam Spano and Jean Spano. 3 American Law Institute, Transnational Insolvency Project, 'International Statement of Canadian Bankruptcy Law, Draft' (Philadelphia: American Law Institute, 1996) at 1-3. 4 An Act to Facilitate Compromises and Arrangements between Companies and Their Creditors, S.C. 1933, c. 36, 23-24 George V, Royal Assent 23 May 1933. 5 Bankruptcy Act, S.C. 1919, c. 3. Early bankruptcy legislation in Canada dates back to 1869, repealed in 1880 because of the amount of fraud and abuse by debtors, and numerous provincial statutes were enacted to fill the void until national bankruptcy legislation was enacted in 1919. Richard McLaren, Canadian Commercial Reorganization: Preventing Bankruptcy (Toronto: Canada Law Book, 1999) at 1-4,1-6. 6 T. Telfer, 'Reconstructing Bankruptcy Law' (1995) 24 C.B.LJ. 357 at 358-9, 361. 7 J. Ziegel, The Modernization of Canada's Bankruptcy Law in a Comparative Context' (1998) 33 Texas International Law Journal 1. 8 Telfer, 'Reconstructing Bankruptcy Law,' at 393, 401. 9 McLaren, Canadian Commercial Reorganization, at 1-6. L. Duncan and W. Reilley, Bankruptcy in Canada, 2nd ed. (Toronto: Canadian Legal Authorities Ltd., 1933) at 168. 10 Winding Up Act, R.S.C. 1906, c. 144, now the Winding Up and Restructuring Act, R.S.C. 1985, c. W-ll. 11 Secretary of State Honourable C.H. Cahan, Remarks on the Introduction of Bill 77 (20 Apr. 1933), Dominion of Canada, Official Report of the Debates, House of Commons, 4th session, 17th Parliament 23-24 George V, Volume IV (Ottawa: King's Printer, 1933) at 4090. 12 Ibid. The 1933 legislation required a majority of creditors by class and three-quarters in value to approve the plan before the court would sanction it. Companies Act, 1929,1929, c. 23 (U.K.). 13 David Skeel, Debt's Dominion: A History of Bankruptcy Law in America (Princeton: Princeton University Press, 2001) at 74. 14 Secretary of State Cahan, Committee as a Whole Debates on CCAA (9 May 1933) (Ottawa: King's Printer, 1933) at 23. Second reading (24 Apr. 1933), third reading (9 May 1933). 15 This was confirmed by Bob LeRiche, Reference Librarian, Parliamentary Library, House of Commons, Ottawa, interviews, 24 Apr. and 26 Apr. 1999. 16 Honourable Arthur Meighen (10 May 1933), Debates of the Senate of the Dominion of Canada, 1933 Official Report, 4th session, 17th Parliament, 23-24 George V (Ottawa: King's Printer, 1933) at 474.

Notes to pages 14-18

299

17 J. Honsberger, Debt Restructuring: Principles and Practice (Aurora: Canada Law Book, 1993) at 9.04. 18 In the early 1990s, courts recognized the creation of instant trust deeds to by-pass this requirement and in 1997 the requirement was eliminated from the statute. McLaren, Canadian Commercial Reorganization, at 1-16. 19 Stanley Edwards, 'Reorganizations under the Companies' Creditors Arrangement Act' (1947) 25 Canadian Bar Review 587 at 589-90. 20 See for example, Re Dairy Corporation of Canada Ltd. (1934), 1 O.R. 436, the first judgment setting out the tests for determining whether the plan is fair and reasonable. See also Edwards, 'Reorganizations.' 21 Feifer v. Frame Manufacturing Corporation (1947), 28 C.B.R. 124 (Que. C.A.). 22 See for example, Charles Warren, Bankruptcy in United States History (Cambridge: Harvard University Press, 1935); Skeel, Debt's Dominion. 23 Edwards, 'Reorganizations/ at 592-3. 24 Ibid, at 600. 25 Part III, BIA. See for example, Ziegel, 'Modernization of Canada's Bankruptcy Law,' at 108. 26 U.S. Bankruptcy Code, 11 U.S.C. (1988), as amended 1994. 27 Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3, amended S.C. 1997, c. 12 (BIA). In addition, the Federal Winding Up and Restructuring Act, supra, note 10, provides for the liquidation of banks, insurance companies, and trust companies. There are also provincial winding up statutes. 28 Bank Act, s. 427; see also provincial statutes such as the Personal Property Security Act. 29 S. 3(1), CCAA. There is a separate regime aimed at allowing personal bankrupts to restructure their debts, not addressed in this book; see Division II, Consumer Proposals, BIA. 30 Canada Business Corporations Act, R.S.C. 1985, c. C-44, as amended. 31 See for example, the cases of Dome Petroleum and Unitel Communications in J. Ziegel and D. Baird, eds., Case Studies in Recent Canadian Insolvency Reorganizations, In Honour of the Honourable Lloyd W. Houlden (Scarborough: Carswell, 1997) and Policy Statement of Director ofCBCA (1994) 17 O.S.C.B. 4853, cited in S.D. Belcher and A.J. Kent, The Restructuring of Unitel Communications Inc.' in Ziegel and Baird, Case Studies, at 616-17. 32 Simon Scott, 'The Acquisition of Dome Petroleum Limited by Amoco Corporation,' in Ziegel and Baird, Case Studies at 300, citing unreported judgment (28 Jan. 1988) (Alta. Q.B.) at 311, 313. 33 Dylex (4 May 1995), Court File No. B-4/95 (Ont. Ct J. (Gen. Div.), Commercial List.), Houlden J.A. 34 Olympia & York Developments v. Royal Trust Co. (1993), 18 C.B.R. (3d) 176 (Ont. Ct J. (Gen. Div.)).

300 Notes to pages 19-22 35 Ss. 80,112, 248, Income Tax Act, R.S.C. 1985, c. 1, as amended. D.M. Sherman, ed., The Practitioner's Income Tax Act, 5th supplement (Scarborough: Carswell, 2000). 36 Pioneer Distributions Ltd. v. Bank of Montreal, [1995] 1 W.W.R. 48 (B.C.S.C.) at paras. 17-20. 37 Honourable Pierre Blais, Minister of Consumer and Corporate Affairs, Remarks to the Canadian Insolvency Institute Conference, Ottawa, (Industry Canada, 1991) at 1, 4. 38 Jacob Ziegel, Benjamin Geva, and R.C.C. Cuming, Secured Transactions in Personal Property, Suretyships and Insolvency, Volume III, Commercial and Consumer Transactions, Cases, Text and Materials, 3rd ed. (Toronto: Emond Montgomery Publications Ltd., 1995) at 761. 39 Office of the Superintendent of Bankruptcy, Annual Statistical Report, 2001 (Industry Canada, 2002). 40 S. 244, BIA. 41 S. 2(1), BIA. 42 G. Triantis, The Interplay Between Liquidation and Reorganization in Bankruptcy: The Role of Screens, Gatekeepers and Guillotines' (1996) 16 Int. Rev. Law & Economics 101 at 103. 43 S. 2(1), BIA. Mutual Trust Co. v. Scott, Pichelli & Graci Ltd. (1999), 11 C.B.R. (4th) 54 (Ont. C.J.). 44 Ss. 50, 50.4(1), 69.31, BIA. There are exceptions to the stay. For example, if the secured creditor already took possession of secured assets prior to the filing of the notice of intention, it is not stayed, or if the secured creditor gave s. 244 Notice of Intention to enforce security more than ten days prior to the filing of the notice of intention or filing of proposal, it is not stayed. P. Casey and H. Reiter, Commercial Proposals under the Bankruptcy and Insolvency Act (Toronto: CBAO Conference, 1996) at 10. 45 S. 50.4(9), BIA. 46 Algoma Steel Corporation (1992), Court File No. B62191-A (Ont. Ct (Gen. Div.)). 47 Ss. 50.4(8)(a), 50.4(2), 50(7), and 50(8), BIA. 48 Canadian Glacier Beverage Corporation v. Barnes and Kissack Inc. (1999), 6 C.B.R. (4th) 212 (B.C.S.C.) at para. 35; Mutual Trust Co. v. Scott, Pichelli & Graci Ltd. (1999), 11 C.B.R. (4th) 54, additional reasons at (1999), 11 C.B.R. (4th) 62 (Ont. Bankruptcy). 49 S. 57, BIA. 50 Ss. 50(7), 61(1), BIA. 51 S. 50.4(9), BIA; Re Baldwin Valley Investors Inc. (1994), 23 C.B.R. (3d) 219 (Ont. Gen. Div.).

Notes to pages 23-6

301

52 S. 58, BIA. 53 Re Eagle Mining Ltd. (1999), 42 O.K. (3d) 571 (Ont. Ct J. (Gen. Div.)); Re Aquatex Corporation (1998), 8 C.B.R. (4th) 177 (Alta. Q.B.); Re Sumner Co. (1984) Ltd. (1987), 64 C.B.R. (N.S.) 218 (N.B.Q.B.); Re Stone (1976), 22 C.B.R. (N.S.) 162 (Ont. S.C.). Ss. 59(2), 198,199, 200, BIA. 54 Bruce v. Neiff Joseph Land Surveyors Ltd. (1977), 23 C.B.R. (N.S.) 258 (N.S.C.A.). 55 Mutual Trust, supra, note 48 at para. 18. Re Davis (1924), 5 C.B.R. 182 (S.C.). 56 S. 59, BIA; Re Eagle Mining, supra, note 53. 57 Ss. 60(1), (1.3), 136, BIA. 58 S. 60(1.1) BIA; s. 224 (1.2), Income Tax Act, supra, note 35. 59 S. 63(1), BIA; 544553 B.C. Ltd. v. Sunshine Coast Mechanical Contractors Inc., [2000] B.C.J. No. 1217 (B.C.C.A.). 60 Dylex, supra, note 33 at 111; Canadian Red Cross (9 Aug. 1998), Court File No. 98-CL-002970 (Ont. Ct J. (Gen. Div.), Commercial List), Blair J. at 21. 61 Lehndorff General Partner Ltd. (1993), 17 C.B.R. (3d) 24 (Ont. Ct J. (Gen. Div.)) at 31; References re CCAA, [1934] S.C.R. 659 at 661; Quintette Coal Ltd. v. Nippon Steel Corp. (1990), 2 C.B.R. (3d) 303 (B.C.C.A.), affirming (1990), 2 C.B.R. (3d) 291, leave to appeal dismissed (1991), 7 C.B.R. (3d) 164 (S.C.C.). 62 Hongkong Bank of Canada v. Chef Ready Foods Ltd. (1991), 51 B.C.L.R. (2d) 84 (B.C.C.A.) at 88. 63 S. 2, CCAA. 64 S. 2, CCAA. Similarly, the trustee is an unsecured creditor for purposes of the Act except that the trustee does not have the right to vote at a creditors' meeting in respect of the bonds. 65 For example, in Cadillac Fairview, it was Whitehall Street Real Estate Ltd. Partnership, a U.S. 'vulture' fund that made the CCAA application on 19 December 1994. The corporation did not hear about the application under after the initial order was made. B. Goldberg, A Guide to Enforcing Security in Ontario (Toronto: CBAO, 1997) at 48. 66 Northland Properties Ltd. (1988), 73 C.B.R. (N.S.) 146 (B.C.S.C.); Sairex GmbH v. Prudential Steel Ltd. (1991), 8 C.B.R. (3d) 62 (Ont. Ct J. (Gen. Div.)). 67 Re Downtown Lumber (1996), 39 C.B.R. (3d) 4 (N.B.C.A.). 68 Tache Construction Ltee c. Banque Lloyds du Canada (1990), 5 C.B.R. (3d) 151 (Que. S.C.). 69 J. Latham, General Overview of the Bankruptcy and Insolvency Act (Toronto: CBAO, 1998) at 5.

302 Notes to pages 26-32 70 71 72 73

74 75

76 77

78

S. 11.7(3), CCAA. S. 5.1 CCAA. There is a parallel provision in the BIA, ss. 50(13), (15). Elan Corporation v. Comiskey (1990), 41 O.A.C. 282. Hydrogenal Inc. v. PCI Chemicals Canada Inc., [2002] J.Q. no. 433 (C.s.Q.), Mayrand, J. See also Elan Corporation, supra, note 72; Algoma Steel Corporation v. Royal Bank of Canada, (16 Apr. 1992) [O.J. 795] (Ont. Ct J. (Gen. Div.), Commercial List). Hongkong Bank of Canada v. Chef Ready Foods Ltd. (1990), 4 C.B.R. (3d) 311 (B.C.C.A.). Mr Justice Tysoe, 'Quintette Coal - The Story of its Reorganization,' in Ziegel and Baird, Case Studies, 377 at 396. Re Quintette Coal Ltd. (1991), 62 B.C.L.R. (2d) 218 (S.C.) at 240. Royal Bank v. Fracmaster, (1999) A.B.C.A. 178. Re Campeau Corporation (1992), 10 C.B.R. (3d) 100, 86 D.L.R. (4th) 570; Oakwood Petroleum Products (1988), 72 C.B.R. (N.S.) 1 (Alta. Q.B.), Forsyth J. Northland Properties, supra, note 66. S. 11.3, CCAA.

2 Current Theoretical Approaches to Insolvency Law 1 Lynn LoPucki and George Triantis, 'A Systems Approach to Comparing U.S. and Canadian Reorganization of Financially Distressed Companies/ in Jacob Ziegel, ed., Current Developments in International and Comparative Corporate Insolvency Law (Oxford: Clarendon Press, 1994) at 109. 2 American Law Institute, 'International Statement of Canadian Bankruptcy Law' (Philadelphia: American Law Institute, 1996) at 47. 3 Thomas Jackson, 'Translating Assets and Liabilities in the Bankruptcy Forum,' in J.S. Bhandari and L.A. Weiss, eds., Corporate Bankruptcy: Economic and Legal Perspectives (Cambridge: Cambridge University Press, 1996) at 53. 4 CCAA; U.S. Bankruptcy Code; Insolvency Act, 1986, United Kingdom, P. II, ss. 8-27; Loi no. 85-88 relative au redressement et la liquidation judiciaire des entreprises. Law Nos. 85-88 and 85-89, Decree Nos. 85-1388 and 85-1389, France. 5 Hon. Richard Posner, Chief Judge, U.S. Court of Appeals for the Seventh Circuit, 'Foreword,' in Bhandari and Weiss, Corporate Bankruptcy: Economic and Legal Perspectives, at xi. 6 A. Schwartz, 'A Theory of Loan Priorities,' in Bhandari and Weiss, Corporate Bankruptcy: Economic and Legal Perspectives sets out these three principles at 17.

Notes to pages 32-7 303 7 Jackson, 'Translating Assets,' at 57. 8 J. Gordon, 'The Shaping Force of Corporate Law in the New Economic Order' (1997) 31 U. Richmond Law Review 1473 at 1474. 9 Lynne Dallas, 'The New Managerialism and Diversity on Corporate Boards of Directors' (2002) 76 Tulane Law Review 1363; Claire Moore Dickerson, 'Human Rights: The Emerging Norm of Corporate Social Responsibility' (2002) 76 Tulane Law Review 1431, Faith Kahn, 'Remember the Titans: Enron's Board, Corporate Transparency and Why it Matters' (2002) 76 Tulane Law Review 1579; Marleen O'Connor, 'The Enron Board and Implications of Group Think' (2002, American Law and Society paper). 10 Note that 'bankruptcy law' in the United States includes what Canadian law refers to as 'insolvency law.' Restructuring is 'reorganization' in the United States and these terms are reflected in the legal scholarship. 11 Axel Flessner, 'Philosophies of Business Bankruptcy Law: An International Overview,' in Ziegel, ed., Current Developments in International and Comparative Corporate Insolvency Law, 19-21; J, Macey, 'Comparative Corporate Law' (paper presented to Faculty of Law, University of Toronto, 1996). 12 Macey has called this 'managerial horizon,' where short-term share price takes priority whether or not it is a measure of good corporate decision making. Macey, 'Comparative Corporate Law.' 13 Robert Rasmussen, The Ex Ante Effects of Bankruptcy Reform on Investment Incentives' (1994) 72 Wash. U. Law Quarterly 1159. 14 Barry Adler, 'Finance's Theoretical Divide and the Proper Role of Insolvency Rules' (1994) 67 Southern California Law Review 1082 at 1109. See also M. Bradley and M. Rosenzweig, 'The Untenable Case for Chapter 11' (1992) 101 Yale Law Journal 1043. 15 Rasmussen, 'Ex Ante Effects of Bankruptcy Reform,' at 1191. 16 Margaret Blair, Ownership and Control: Rethinking Corporate Governance for the Twenty-First Century (Washington, DC: Brookings Institute, 1995) at 209-10. 17 LoPucki and Triantis, 'Systems Approach,' at 109. 18 Thomas Jackson, The Logic and Limits of Bankruptcy Law (Cambridge: Harvard University Press, 1986) at 58, 72. Douglas Baird, 'Loss Distribution, Forum Shopping and Bankruptcy: A Reply to Warren' (1987) 54 U. Chicago Law Review 815; Douglas Baird and Thomas Jackson, 'Corporate Reorganizations and the Treatment of Diverse Ownership Interests: A Comment on Adequate Protection of Secured Creditors in Bankruptcy' (1984) 51 U. Chicago Law Review 97 at 103.

304 Notes to pages 37-42 19 Karen Gross, Failure and Forgiveness: Rebalancing the Bankruptcy System (New Haven: Yale University Press, 1997). 20 Jackson, Logic and Limits of Bankruptcy Law at 58; Douglas Baird, 'A World Without Bankruptcy/ in Bhandari and Weiss, Corporate Bankruptcy: Economic and Legal Perspectives, 29 at 33, 37. 21 Jackson, Logic and Limits of Bankruptcy Law, at 2. Baird, 'Loss Distribution/ at 820. 22 Jackson, Logic and Limits of Bankruptcy Law, at 53, 212. 23 Ibid, at 59-61. 24 Baird concludes that one cannot argue for a special set of distributional concerns arising when a debtor defaults to many creditors at one time. Baird, 'Loss Distribution/ at 822. 25 Ibid, at 100. 26 Elizabeth Warren, 'Bankruptcy Policy' (1987) 54 University of Chicago law Review 775 at 812. 27 Flessner, 'Philosophies of Business Bankruptcy Law/ at 25. 28 Mark Kessel, 'International Aspects of Corporate Governance, A United States Perspective' (CBA Conference on Corporate Governance, Vancouver, 1997) at 2. Blair, Ownership and Control, at 3,16. 29 M.C. Jensen and W.H. Meckling, 'Theory of the Firm: Managerial Behaviour, Agency Costs and Ownership Structure' (1976) 3 Journal of Financial Economics 305 at 305-16. 30 Ron Daniels, 'Stakeholders and Takeovers: Can Contractarianism Be Compassionate' (1993) 43 U.T.L.J. 315 at 351. 31 Jensen and Meckling, 'Theory of the Firm/ at 308-16. 32 Jonathan Macey and Geoffrey Miller, 'Corporate Stakeholders: A Contractual Perspective' (1993) 43 U.T.L.J. 401 at 417. J.G. Macintosh, 'Designing an Efficient Fiduciary Law' (1993) 43 U.T.L.J. 425. 33 C. Bathala and R. Rao, 'The Determinants of Board Composition: An Agency Theory Perspective' (1995) 16 Managerial and Decision Econ. 59 at 61; E. Fama and M. Jensen, 'Separation of Ownership and Control' (1983) 26 Journal of Law and Economics 301 at 315; O. Hart, 'An Economist's View of Fiduciary Duty' (1993) 43 U.T.L.J. 299 at 303. 34 Thomas Smith, 'The Efficient Norm for Corporate Law: A Neotraditional Interpretation of Fiduciary Duty' (1999) 98 Michigan Law Review 214. 35 Ronald Daniels, 'Must Boards Go Overboard? An Economic Analysis of the Effects of Burgeoning Statutory Liability on the Role of Directors in Corporate Governance' (1994-5) 24 C.B.L.J. 229 at 231. 36 J. Coffee, 'Unstable Coalitions: Corporate Governance as a Multi-player Game' (1990) 78 Georgetown L.J. 1495 at 1523. J. Singer, 'The Reliance Interest in Property' (1988) 40 Stanford L.R. 611.

Notes to pages 43-8

305

37 Gross, Failure and Forgiveness, at 144,164,167, 247. 38 Ibid, at 165, 247. 39 Christopher Frost, 'Bankruptcy Redistribution Policy and the Limits of Judicial Process' (1995) 74 N.C. Law Rev. 75 at 129-32; A. Schwartz, 'A Contract Theory Approach to Business Bankruptcy' (1998) 107 Yale Law Journal 1807; Susan Block-Lieb, 'Book Review: A Humanistic Vision of Bankruptcy Law' (1998) 6 American Bankruptcy Institute Law Review 471, 473. 40 Susan Block-Lieb, 'The Unsecured Creditors' Bargain' (1994) 80 Va. L. Rev. 1989 at 1995. 41 Karen Gross, 'On the Merits: A Response to Professors Girth and White' (1999) American Bankruptcy Law Journal 485 at 495-6. 42 Marjorie Girth, 'Rethinking Fairness in Bankruptcy Proceedings' (1999) American Bankruptcy Law Journal 449 at 463. 43 Gross, 'On the Merits,' at 496. 44 Ibid, at 487. 45 Girth, 'Rethinking Fairness,' at 474. 46 Christopher Frost, 'The Theory, Reality and Pragmatism of Corporate Governance in Bankruptcy Reorganizations' (1998) Am. Bankruptcy Law Journal 103 at 130. 47 Smith, 'Efficient Norm for Corporate Law'; G. Crespi, 'Rethinking Corporate Fiduciary Duties: The Inefficiency of the Shareholder Primacy Norm' (2002) 55 S.M.U. Law Review 141. 48 Crespi, 'Rethinking Corporate Fiduciary Duties/ at 152. 49 Geyer v. Ingersoll Publications Co., 621 A. 2d 784 (Del. Ch. 1992); Ben Franklin Retail Stores, 2000 U.S. Dist. Lexis 11; Re Healthco, 208 B.R. 300; Odyssey Partners, 735 A.2d 417; Stephen McDonnell, 'Geyer v. Ingersoll Publications Co: Insolvency Shifts Directors' Burden from Shareholders to Creditors' (1994) 19 Del. J. Corp. L. 177; B. Nicholson, 'Recent Delaware Case Law Regarding Directors' Duties to Bondholders' (1994) 19 Del. J. Corp. L. 573; C. Barnett, 'Healthco and the "Insolvency Exception": An Unnecessary Expansion of the Doctrine?' (2000) 16 Bankr. Dev. J. 441. 50 Crespi, 'Rethinking Corporate Fiduciary Duties,' at 148. 51 Joseph Stiglitz, 'Some Aspects of the Pure Theory of Corporate Finance: Bankruptcies and Takeovers' (1972) 3 Bell J. EC. and Management Science 458; Warren, 'Bankruptcy Policy,' at 775-80. 52 Elizabeth Warren, 'Bankruptcy Policy Making in an Imperfect World' (1993) 92 Mich. Law Rev. 336. 53 Warren, 'Bankruptcy Policy,' at 779, 791-2; Elizabeth Warren, The Untenable Case for Repeal of Chapter 11' (1992) 102 Yale Law Journal 437 at 467.

306 Notes to pages 48-54 54 Blair, Ownership and Control, at 189. 55 Ibid, at 236. Lynne Dallas, The Relational Board: Three Theories of Corporate Boards of Directors' (1996) 22 Journal of Corporation Law 1 at 8,16. 56 Bernard Black, 'Corporate Law and Residual Claimants' (Columbia University School of Law, Centre for Law and Economic Studies, 1996) [working paper, cited with permission] at 19, 36. 57 Andrew Keay, 'Insolvency Law: A Matter of Public Interest?' (2000) 51 Northern Ireland Legal Quarterly 509 at 510. 58 Ibid., at 522-3. 59 Gross, Failure and Forgiveness, at 120; Michelle White, The Corporate Bankruptcy Decision/ in Bhandari and Weiss, Corporate Bankruptcy: Economic and Legal Perspectives, at 207, 226-7. 60 Frost, 'Bankruptcy Redistribution Policy/ at 122. Panel discussion, 'What Constitutes Success in a Chapter 11? A Roundtable Discussion' (1994) 2 Am. Bankruptcy Institute Law Review 229 at 233-7. 61 Blair, Ownership and Control, at 240. 62 Kevin Kordana and Eric Posner, 'A Positive Theory of Chapter 11' (1999) 74 N.Y.U.L. Rev. 161 at 165. 63 Michelle White, The Costs of Bankruptcy: A U.S. - European Comparison/ in Bhandari and Weiss, Corporate Bankruptcy: Economic and Legal Perspectives, at 487-8. 64 Theodore Eisenberg and Shoichi Tagashira, 'Should We Abolish Chapter 11? The Evidence from Japan' in Bhandari and Weiss, Corporate Bankruptcy: Economic and Legal Perspectives, 501 at 503. 65 LoPucki and Triantis, 'Systems Approach/ at 102,104. 66 Julian Franks and Walter Torous, 'Lessons from a Comparison of U.S. and U.K. Insolvency Codes/ in Bhandari and Weiss, Corporate Bankruptcy: Economic and Legal Perspectives, at 450-2; LoPucki and Triantis, 'Systems Approach/ at 102,104. 67 Christopher Frost, 'Running the Asylum: Governance Problems in Bankruptcy Reorganizations' (1992) 34 Arizona Law Review 89 at 94. 68 White, 'Costs of Bankruptcy/ at 467. 69 Michael Conte and Jan Svejnar, 'Employee Ownership Plans/ in Alan Blinder, ed., Paying for Productivity (Washington, DC: Brookings Institute, 1990) at 143. 70 William Aziz, C.R.O. White Rose Crafts and Nursery Limited, 'Remarks to the Canadian Turnaround Management Association/ excerpts, Globe and Mail (20 Apr. 1999) at BIO.

Notes to pages 54-60 307 71 R.G. Marantz, 'Debtor's Defensive Strategies' (Insight Conference, Toronto, 1991) at 2-3. 72 Aziz, 'Remarks/ at BIO. Bernard Wilson, 'The Creditors' and Debtors' Guide to Survival and Success' (1994), 28 C.B.R. (3d) 25, cited to InsolvencyPro on-line research, www.Carswell.insolvencypro (Scarborough: Carswell, 1999) at 26. 3 Proposing a Conceptual Framework for Reconciling Stakeholder Interests 1 Oxford Illustrated Dictionary (Oxford: Clarendon Press, 1970) at 858. 2 Olympia & York Developments v. Royal Trust Co. (1993), 18 C.B.R. (3d) 176 (Ont. Ct J. (Gen. Div.)) at para. 81. 3 Anvil Range Mining Corporation, Endorsement (20 Aug. 1998), Court File No. 98-BK-001268, (Ont. Ct J. (Gen. Div.), Commercial List), Blair J. 4 T. Jackson, R. Scott, 'On the Nature of Bankruptcy: An Essay on Bankruptcy Sharing and the Creditors' Bargain,' in J.S. Bhandari and L.A. Weiss, eds., Corporate Bankruptcy: Economic and Legal Perspectives (Cambridge: Cambridge University Press, 1996) at 145. 5 Laura Lin, 'Shift of Fiduciary Duty Upon Corporate Insolvency: Proper Scope of Directors' Duty to Creditors' (1993) 46 Vanderbilt Law Review 1485 at 1497. 6 R.E. Scott, The Truth about Secured Financing' (1997) 82 Cornell Law Review 1436 at 1462. 7 J. Gordon, The Shaping Force of Corporate Law in the New Economic Order' (1997) 31 U. Richmond Law Review 1473 at 1477. 8 Edward Sellers et al., 'Governance of the Financially Distressed Corporation: New Challenges for Refinancing in Global Capital Markets' in J. Sarra, ed. Corporate Governance in Global Capital Markets (Vancouver: UBC Press, 2003). 9 Ibid, at 17. 10 M. White, The Costs of Bankruptcy: A U.S.-European Comparison,' in Bhandari and Weiss, Corporate Bankruptcy: Economic and Legal Perspectives at 487. 11 J. Ziegel and K. Davis, 'Protecting Vulnerable Creditors in Insolvency,' Faculty of Law, University of Toronto, 1998 (unpublished, cited with permission) at 7. 12 S. 136(l)(f), BIA. 13 See for example, the Personal Property Security Act, R.S.O. 1990, c. P.10 at s. 33.

308 Notes to pages 60-73 14 S. 81.1, BIA. Re T. Eaton Co., [1999] OJ. No. 3277 (Ont. S.CJ. (Commercial List)), at para. 15. 15 Re Woodwards Ltd. (1990), 100 D.L.R. (4th) 133 and (1993), 17 C.B.R. (3d) 253 (B.C.S.C.). 16 Yukon Miners Lien Act, S.Y. 1996, c. 116; Ontario Repair and Storage Liens Act, R.S.O. 1990, c. R.25. 17 Re Royal Oaks Mines (14 Mar. 1999) (Ont.S.C.J. (Commercial List)), Farley J. However, see Re Sulphur Corporation of Canada Ltd., [2002] A.J. No. 918 (Alta. Q.B.) for a different interpretation. 18 Douglas Baird and R.C. Picker, 'A Simple Non-cooperative Bargaining Model of Corporation Reorganizations,' in Bhandari and Weiss, Corporate Bankruptcy: Economic and Legal Perspectives 168 at 171. 19 Andre Faucault, Executive Vice President, Chemical, Energy and Paperworkers Union, Ottawa, telephone interview, 21 Mar. 1999. Abitibi Paper, Ontario Court File CL1100-05-09. 20 B.R. Cheffins, 'Michaud v. National Bank of Canada and Canadian Corporate Governance: A Victory for Shareholder Rights?' (1998) 30 C.B.L.J. 20. 21 Tsay Key Dene and Takla Indian Bands v. Kemess Mines Inc. (B.C.S.C.) Feb. 1997. Motion Record, Royal Oak Mines, supra, note 17. 22 S. 30(6), CCAA; s. 50(13), BIA. 23 Jackson and Scott, 'On the Nature of Bankruptcy,' at 158. 24 See for example, Re Skydome Corporation, S. Food Services and SAI Siibco Inc. (27 Nov. 1998), Court File No. 98-CL-3179 (Ont. Ct J. (Gen. Div.)), Blair J. 25 Northwest Bank Worthington v. Ahlers, 108 S.Ct. 963 (U.S. Supreme Court 1988). See also John Ayer, 'Rethinking Absolute Priority After Ahlers' (1989) 87 Mich. L. Review 963. 26 D. Benjamin, M. Gunderson, and W.C. Riddell, Labour Market Economics: Theory, Evidence and Policy in Canada (Toronto: McGraw-Hill Ryerson, 1998) at 469. 27 J. Sarra, 'Corporate Governance Reform: Recognition of Workers' Equitable Investments in the Firm' (1999) 32 Canadian Business Law Journal 384. 28 Ron Daniels, 'Stakeholders and Takeovers: Can Contractarianism be Compassionate?' (1993) U.T.L.J. 315. 29 K. Swinton, 'Comment on Labour Participation in Workplace Governance' (1993) U.T.L.J. 793. 30 George Triantis, 'Contractual Allocations of Unknown Risks: A Critique of the Doctrine of Commercial Impracticability' (1992) 42 U.T.L.J. 450. 31 George Triantis, The Effects of Insolvency and Bankruptcy on Contract Performance and Adjustment' (1993) 43 U.T.L.J. 679.

Notes to pages 73-87 309 32 See for example, s. 68 of the Ontario Labour Relations Act, 1995, S.O. 1995, c.l. 33 M. Trebilcock and R. Howse, 'Protecting the Employment Bargain' (1993) 43U.T.LJ. 751 at 761. 34 Daniels, 'Stakeholders and Takeovers/ at 317, 331, 340; Katherine Van Wezel Stone, 'Protecting Employment Contracts within the Nexus of Contracts Firm' (1993) 43 U.T.LJ. 353 at 338, 367. 35 Sarra, 'Corporate Governance Reform/ at 411. 36 Marleen O'Connor, The Human Capital Era: Reconceptualizing Corporate Law to Facilitate Labour-Management Co-operation' (1993) 78 Cornell Law Rev. 899 at 904; A. Hyde, 'Ownership, Contract and Politics in the Protection of Employees Against Risk' (1993) 43 U.T.LJ. 721 at 749; J. Singer, 'Jobs and Justice: Rethinking the Stakeholder Debate' (1993) 43 U.T.LJ. 475 at 480. 37 Benjamin, Gunderson, and Riddell, Labour Market Economics, at 469. 38 This is in contrast to a spot or auction wage system where the value of work equals production at each point in time. Ibid, at 470-1. 39 T. Crossley, S. Jones, and P. Kuhn, 'Gender Difference in Displacement Costs: Evidence and Implications' (1994) 29 Journal of Human Resources 461. 40 B. Davidson et al., 'Management Issues in Corporate Restructuring/ in L. Houlden and G. Morawetz On-Line Newsletter, 4 Apr. 2000 (Scarborough: Carswell) at 1. 41 Ibid, at 5. 42 K. Kordana and E. Posner, 'A Positive Theory of Chapter 11' (1999) 74 N.Y.U.L. Rev. 161 at 176, 180. 43 M. Blair, Ownership and Control: Rethinking Corporate Governance for the Twenty-First Century (Washington, DC: Brookings Institute, 1995) at 243. 44 Michael Rotsztain, 'Dylex - A Tailor Made Restructuring/ in J. Ziegel and D. Baird, eds., Case Studies in Recent Canadian Insolvency Reorganizations, In Honour of the Honourable Lloyd W. Houlden (Scarborough: Carswell, 1997) 425 at 441. Re Sammi Atlas Inc. (1997), 49 C.B.R. (3d) 65 (Ont. Ct J. (Gen. Div.), Commercial List). 45 Re Laidlaw Inc. (2002); OJ. No. 790 (Ont. S.C.J. (Commercial List)). 46 Christopher Frost, The Theory, Reality and Pragmatism of Corporate Governance in Insolvency Reorganizations' (1998) Am. Bank. Law Journal 103 at 135. 47 Blair, Ownership and Control; O'Connor, The Human Capital Era.' 48 Max Mendelsohn, The Re-Emergence of the Blue Box: The Restructuring of Birks Business/ in Ziegel and Baird, Case Studies, 411. Alternatively,

310 Notes to pages 87-99

49

50 51

52 53 54

55 56 57

58 59

60 61 62 63 64

parties could seek status under provincial class proceedings statutes. See for example, the Ontario Class Proceedings Act, 1992, S.O.1992, c. 6. In the Matter of the Proposal of the T. Eaton Company Limited, Court File No. 31OR- 364921, Order (27 Aug. 1999) (Ont. S.C.J. (Commercial List)), Farley J. Re Loewen Group Inc. (2001), O.J. No. 4910 (Ont. S.C.J. (Commercial List)). R. Romano, 'Public Pension Fund Activism in Corporate Governance' (1993) 93 Columbia Law Review 795; K. Montgomery, 'Market Shift - The Role of Institutional Investors in Corporate Governance' (1996) Canadian Business Law Journal 26 at 190-1. Quarterly Estimates of Trusteed Pension Plans, Second Quarter (Ottawa: Statistics Canada, 2001). Cowan v. Scargill, [1984] 2 All E.R. 750 (Ch. D.); Boe v. Alexander (1987), 41 D.L.R. (4th) 520 (B.C.C.A.). Gil Yaron, 'Canadian Institutional Shareholder Activism in an Era of Global Deregulation' in Sarra, ed., Corporate Governance in Global Capital Markets. Ibid. Oakwood Petroleums Ltd., discussed in Richard Jones and Richard Dixon, 'Oakwood Petroleums Ltd.' in Ziegel and Baird, Case Studies, 345 at 371. See for example, First Ontario Labour Sponsored Investment Fund. Kenneth Delaney, president and CEO, interviews, 12 Feb. 1998 and 28 Sept. 2001. Re Royal Oak Mines, supra, note 17, Affidavit of M. Witte, at paras. 16, 53. Fred Myers and Edward Sellers, 'Recognition of Social Stakeholders in Canadian Insolvency Proceedings' (1999) 11 Commercial Insolvency Reporter 6 at 70. Re Skeena Cellulose Inc., In the Matter of the Companies' Creditors Arrangement Act, B.C.S.C., Vancouver Registry No. L012405. Re Dylex Limited (1995), 31 C.B.R. (3d) 106 (Ont. Ct J. (Gen. Div.)), Court File No. B4/95. Karen Gross, Failure and Forgiveness: Rebalancing the Bankruptcy System (New Haven: Yale University Press, 1997) at 212, 238. Rule 13, Ontario Rules of Civil Procedure (Scarborough: Carswell, 1999); 'Highlights, Rule 13,' at 310. Peel (Regional Municipality) v. Great Atlantic and Pacific Co. of Canada (1990), 74 O.R. (2d) 164; General Dynamics Corp. v. Veliotis (1987), 61 O.R. (2d) 111, 21 C.P.C. (2d) 169, 23 O.A.C. 339 (Div. Ct.), leave to appeal refused 21 C.P.C. (2d) 169n.

Notes to pages 99-105

311

65 Re Clark and Attorney General for Canada (1977), 17 O.K. (2d) 593 (Ont. H.C.J.); Morgentaler v. The Queen, [1976] 1 S.C.R. 616. 66 In many cases the security provides for it, however, the court will often appoint a creditors' committee of senior unsecured creditors. 67 Re Cadillac Fairview Inc. (1995), 53 A.C.W.S. (3d) 305 (Ont. Ct (Gen. Div.)). 68 A.A. Berle and G.C. Means, The Modern Corporation and Private Property (New York: Commerce Clearing House, 1932) at 355-6, 69 Alberta Business Corporations Act, R.S.A. 1980, c. B-15, s. 117(4), 820099 Ontario Inc. v. Harold E. Ballard Ltd. (1991), 3 B.L.R. (2d) 113 at 185-7,191. 70 For example, Ontario directors have liabilities under the Ontario Business Corporations Act, R.S.0.1990, c. B.16; Canada Business Corporations Act, R.S.C. 1985, c. C-44, as amended (CBCA); Ontario Securities Act, R.S.O. 1990, c. S.5; Environmental Protection Act, R.S.O. 1990, c. E.19; and Employment Standards Act, R.S.O. 1990, c. E.14, as amended. 71 R. Coase, 'The Institutional Structure of Production' (1992) 82 Am. Econ. Review 713 at 717. 72 Sarra, 'Corporate Governance Reform.' See also K. Klare, 'Comment: Untoward Neutral Principles - Market Failure Implicit Contract and Economic Adjustment Injuries' (1993) 43 U.T.L.J. 393 at 399. 73 T. Donaldson and L. Preston, 'The Stakeholder Theory of the Corporation: Concepts, Evidence, Implications' (1995) Academy of Management Review 65 at 91; Coleman, 'Efficiency, Utility and Wealth Maximization' (1980) 8 Hofstra Law Review 509 at 512. 74 Re Sidaplex-Plastic Suppliers Inc. and the Elta Group Inc. (1998), 40 O.R. (3d) 563 (Ont. C.A.); Peoples Department Stores Inc. v. Wise, [1998] Q.J. No. 3571 (S.C. (Bankruptcy and Insolvency Division)) (Greenberg J.), heard and reserved by Quebec Court of Appeal, 13-14 May 2002; Downtown Eatery (1983) Ltd. v. Ontario (2001), 200 D.L.R. (4th) 289 (Ont. C.A.). 75 J. McCamus, 'Prometheus Unbound: Fiduciary Obligation in the Supreme Court of Canada' (1997).28 C.B.L.J. 107 at 108,112,119-22, citing Hodgkinson v. Simms, [1994] 3 S.C.R. 377; Frame v. Smith, [1987] 2 S.C.R, 99, and Lac Minerals Ltd. v. International Carona Resources Ltd., [1989] 2 S.C.R. 574 at 656-9; C. Parfitt and M. Munro, 'Whose interests are we talking about?: A. (C.)V. Critchley and developments in the law of fiduciary duty,' (1999) 33 U.B.C.L.R. 199 at 202. 76 Parfitt and Munro, 'Whose interests are we talking about?' at 208, 211. 77 However, Lipton and Rosenblum suggest that these statutes do allow directors to consider the interests of the corporation as a business enterprise. M. Lipton and S. Rosenblum, 'A New System of Corporate Cover-

312 Notes to pages 107-16 nance: The Quinquennial Election of Directors' (1991) 58 U. of Chicago Law Review 187. 78 S. Edwards, 'Reorganizations under the Companies' Creditors Arrangement Act' (1947) 25 Canadian Bar Review 587 at 601, 614. 79 Re Quintette Coal Ltd. (1992), 13 C.B.R. (3d) 146 (B.C.S.C.); Olympia & York Developments-Ltd. v. Royal Trust Co. (1993), 17 C.B.R. (3d) 1 (Ont. Ct J. (Gen. Div.), Commercial List). 80 Frost, 'Theory, Reality and Pragmatism of Corporate Governance,' at 114-15. 4 Judicial Discretion under the CCAA 1 Re Olympia & York Developments v. Royal Trust Co. (1993), 17 C.B.R. (3d) 1 (Ont. Ct J. (Gen. Div.)). 2 Re Playdium Entertainment Corp. [2001] O.J. No. 4252 (Ont. S.C.J.), at para. 27; Re Armbro Enterprises Inc. (1993), 22 C.B.R. (3d) 80 (Ont. Ct J. (Gen. Div.)); Icor Oil & Gas Co. v. Canadian Imperial Bank of Commerce (1989), 102 A.R. 161 (Q.B.) at 165. 3 Re Quintette Coal Limited, v. Nippon Steel Corp. (1990), 2 C.B.R. (3d) 303 (B.C.C.A.). 4 Hongkong Bank of Canada v. Chef Ready Foods Ltd. (1990), 4 C.B.R. (3d) 311 (B.C.C.A.); Re Sklar-Pepplar Furniture Corp. v. Bank of Nova Scotia (1991), 8 C.B.R. (3d) 321 (Ont. Gen. Div.) at 314. 5 Re Sklar-Pepplar, supra, note 4. 6 Re Skydome Corporation, Endorsement (27 Nov. 1998), (Ont. Ct J. (Gen. Div.)). 7 Andrew Keay, 'Insolvency Law: A Matter of Public Interest?' (2000) 51 Northern Ireland Legal Quarterly 509 at 533. 8 Michael Rotsztain, 'A Critical Analysis of the Court Receivership Remedy against Commercial Enterprises,' in Corporate Restructurings and Insolvencies, Proceedings of the Queen's Annual Business Law Symposium, 1995 (Scarborough: Carswell, 1995) at 245. 9 M. Barrack, 'Is Judicial Activism in the Restructuring Field Skewing the Negotiating Process?' in Corporate Restructurings and Insolvencies, at 485, 491, 494. Peter Hamilton and George Wade, 'Restructuring under the CCAA: An Examination of Principles and Solutions in Light of the Experience in the U.S.' in ibid, at 1,14. 10 Re Dylex Limited (1995), 31 C.B.R. (3d) 106 (Ont. Ct J. (Gen. Div.), Commercial List), at 110; Re Olympia & York Developments, supra, note 1 at 168; Re NsC Diesel Power Inc. (1990), 79 C.B.R. (N.S.) 1 (N.S.S.C.); Westar Mining

Notes to pages 116-22 313

11 12 13 14

15 16 17 18 19

20 21

22 23

24 25 26

27 28 29

(1992), 14 C.B.R. (3d) 88 (B.C.S.C.); Interpretation Act, R.S.C. 1985, c. 1-21, s.12. J. Resnick, 'Managerial Judges' (1982) 96 Harvard Law Review 374 at 378. Barrack, 'Judicial Activism/ at 489-90. R. Gordon Marantz, 'Facilitating Arrangements - A Dynamic Process/ in Corporate Restructurings and Insolvencies, at 507. In 2001-2 the federal government held consultations across Canada in preparation for considering amendments to the BIA and CCAA in a parliamentary review to take place in 2003. Karen Gross, 'On the Merits: A Response to Professors Girth and White' (1999) American Bankruptcy Law Journal 485 at 488. Hamilton and Wade, 'Restructuring Under the CCAA/ 10-13. F. Myers and E. Sellers, 'Recognition of Social Stakeholders in Canadian Insolvency Proceedings' (1999) 11 Commercial Insolvency Reporter 6 at 66. Forsyth J., 'Judicial Discretion under the CCAA,' in Corporate Restructurings and Insolvencies. Farley J. in 'The Judges Speak/ in J. Ziegel, ed., Current Developments in International and Comparative Corporate Insolvency Law (Oxford: Clarendon Press, 1994) at 768. Blair J., in 'The Judges Speak/ at 768-9. Campeau v. Olympia & York Developments Ltd. (1992), 14 C.B.R. (3d) 303 (Ont. Ct J. (Gen. Div.)) at para. 17; First Treasury Financial Inc. v. Cango Petroleums Inc. (1991), 3 C.B.R. (3d) 232 (Ont. Ct J. (Gen. Div.)); Re Ursel Investments Ltd. (1991), 2 C.B.R. (3d) 260 (Sask. Q.B.). Re Inducon Development Corp. (3 Jan. 1992), Court File No. B364/92 (Ont. Ct J. (Gen. Div.)). Re Philips Manufacturing Ltd. (1992), 9 C.B.R. (3d) 25 (B.C.C.A.) at 28. See also Re Sharp-Rite Technologies Ltd., [2000] B.C.J. No. 135 (B.C.S.C.); Bargain Harolds Discount Ltd. v. Paribas Bank of Canada (1992), 10 C.B.R. (3d) 23 (Ont. Ct J. (Gen. Div.)). Re Blue Range Resource Corp., [2000] A.J. No. 1032 (Alta. C.A.) at para. 7. Hongkong Bank of Canada v. Chef Ready Foods Ltd., supra, note 4. Re Hunters Trailer & Marine Ltd., [2001] A.J. No. 857 (Alta. Q.B.) at para. 16; Re Smoky River Coal Ltd. (2000), 19 C.B.R. (4th) 281 (Alta. Q.B.) at 290; Bargain Harolds Discount Ltd. (1992), 7 O.R. (3d) 362 (Ont. Ct (Gen. Div.)) at 370-1. Campeau v. Olympia & York, supra, note 21. Hamilton and Wade, 'Restructuring under the CCAA,' at 13. Re Hunters Trailer & Marine Ltd., supra, note 26; Re Alberta Pacific Terminals Ltd. (1991), 8 C.B.R. (3d) 99 (B.C.S.C.) at 105.

314 Notes to pages 122-6 30 Re Royal Oak Mines Inc. (10 Mar. 1999), O.J. No. 709 (Ont. S.C.J. (Commercial List)) Blair J., at paras. 8, 9,15,17. 31 S. 11(4), CCAA; Re Royal Oak Mines Inc. supra, note 30; Re Playdium Entertainment Corp., [2001] O.J. No. 4252 (Ont. S.C.J.). 32 Re Skeena Cellulose Inc., [2001] B.C.J. No. 2226 (B.C.S.C.). 33 Toronto Stock Exchange Inc. v. United Keno Hill Mines (2000), 48 O.K. (3d) 476 (Ont. S.C.J.). See also Re Versatech Group Inc., [2000] O.J. No. 3785 (Ont. S.C.J.). 34 Re PSINet Ltd., [2002] O.J. No. 271, Court File No. 01CL4155 (Ont. S.C.J.). 35 Re Algoma Steel Inc., [2001] O.J. No. 1943 (Ont. C.A.) at para. 8; Re Pacific National Lease Holding Corp. (1992), 15 C.B.R. (3d) 365 (B.C.C.A.). 36 Consumers Packaging Inc. (10 Oct. 2001), File No. M27743 (Ont. C.A.). 37 United Used Auto and Truck Parts Ltd. v. Aziz (28 Feb. 2000) (B.C.C.A.), Docket CA026591 (2000 BCCA 146). Re Dylex Limited (23 Jan. 1995), Ontario Court File No. B-4/95 (Ont. Ct J. (Gen. Div.)), Houlden J.A.; Re The T. Eaton Company Ltd. and other companies (27 Feb. 1997), Court File No. RE-7483/97 (Ont. Ct J. (Gen. Div.)), Houlden J.A. 38 Geoffrey Morawetz, The Canadian Version of DIP Financing,' L. Houlden and G. Morawetz, Insolvency Pro, On-Line Newsletter (Toronto: Carswell, 1999) at 1, (www.Carswell.insolvencypro). 39 Mr Justice Farley, citing Halsbury's Volume 37, 4th ed., at para. 14, in Re Royal Oak Mines, Inc. (14 Mar. 1999), Court File No. 98-CL-3278 (Ont. S.C.J. (Commercial List)), Farley J. at para 22. 40 Baxter Student Housing Ltd. v. College Housing Co-operative Ltd., [1976] 2 S.C.R. 475 at 480. 41 Re Westar Mining Ltd. (1992), 14 C.B.R. (3d) 88 (B.C.S.C); Skydome Corporation, supra, note 6; Re Dylex Limited, supra, note 10; Re Chef Ready Foods Ltd. (1990), 4 C.B.R. (3d) 307 (B.C.S.C.), aff'd [1991] 2 W.W.R. 136 (B.C.C.A.); Canadian Asbestos Services Ltd. v. Bank of Montreal (1992), 11 O.R. (3d) 353 (Ont. Ct J. (Gen. Div.)); supplemental reasons (1993), 13 O.R. (3d) 291 (Ont. Ct J. (Gen. Div.)). 42 United Used Auto, supra, note 37 at paras. 2, 9,12. 43 Re Skydome Corporation, supra, note 6 at 5; Re Royal Oak Mines, Inc. (14 Mar. 1999), Court File No. 98-CL-3278 (Ont. S.C.J. (Commercial List)) at para. 22. Re United Used Auto & Truck Parts Ltd., unreported decision of Tysoe J. dated 19 Nov. 1999, Docket Vancouver A992950 (B.C.S.C.). Re Sharp Rite Technologies Ltd., [2000] B.C.J. No. 135 (B.C.S.C.) at paras. 43-6. 44 GE Capital v. Euro United Corporation, endorsement of Blair J. Dec. 24, 1999-99 - Ont. file no. 99-CL3592.

Notes to pages 126-32 315 45 Re Royal Oak Mines, supra, note 30 at para. 9,11,12,21, 24, citing Baxter Student Housing Ltd. v. College Housing Co-operative Limited (1975), 57 D.L.R. (3d) 1 (S.C.C.) and Canada (Minister of Indian Affairs and Northern Developments v. Curragh Inc. (1994), 27 C.B.R. (3d) 148 (Ont. Ct J. (Gen. Div.)); Builders Lien Act, R.S.B.C, 1996, c. 41 at s. 11. However, an Alberta court recently determined that lien provisions did not limit the court's authority to give super-priority in DIP financing, Re Sulphur Corporation of Canada Ltd., [2002] A.J. No. 918 (Alta. Q.B.). 46 H.A. Zimmerman, 'Financing the Debtor in Possession,' paper presented to the Tenth Annual Meeting and Conference of The Insolvency Institute of Canada, Nov. 1999, Insolvency Pro, Carswell Publishing at 15. 47 United Used Auto, supra, note 37 at paras. 25, 28, 30. 48 Re Hunters Trailer & Marine Ltd., supra, note 26 at paras. 32-4. 49 In Royal Oak Mines, a portion of the DIP financing was aimed at environmental protection. 50 Re Algoma Steel Inc., [2001] O.J. No. 1994 (Ont. S.C.J.), leave to appeal dismissed [2001] O.J. No. 1943 (Ont. C.A.). 51 J. Sarra, 'Debtor in Possession Financing: The Jurisdiction of Canadian Courts to Grant Superpriority Financing in CCAA Applications' (2000) 23 Dalhousie Law Journal 337-84. 52 Re Algoma Steel Inc., [2001] O.J. No. 1943 (Ont. C.A.) at para. 2. 53 Re Hunters Trailer & Marine Ltd., [2001] A.J. No. 1638 (Alta. Q.B.). The court noted that at the time this was heard, 26 Nov. 2001, there was no case law directly on point in terms of allocation of CCAA costs. 54 Re Canada 3000 Inc. et al. (2001), Toronto Ol-CL-4314 (Ont. S.C.J.); Re Dylex Ltd., [2002] O.J. No. 1505 (Ont, S.C.J.); Re Philip Services Corporation, Court File Nos. 99-CL-3442 and 4166 CP/98; Re T. Eaton Co. Ltd. (1997), 46 C.B.R. (3d) 293 (Ont. Ct. (Gen. Div.)); Re Consumers Packaging Inc. (23 May 2001) (Ont. S.C.J.). 55 Re United Used Auto, supra; Re Hunters Trailer, supra, note 53. 56 Re Smoky River Coal Ltd., [2001] A.J. No. 1006 (Alta. C.A.); [2001] A.J. No. 925 (Alta. Q.B.) Lo Vecchio, J. 57 Ibid, at para. 17. 58 Re Dylex Ltd., [2002] O.J. No. 1505 (Ont. S.C.J.) Cullity, J. 59 Re Laidlaw Inc., [2002] O.J. No. 947 (Ont. S.C.J.); see also Re Canadian Airlines Corp. (2000), 20 C.B.R. (4th) 1 (Alta. Q.B.). 60 Norcen Energy Resources Ltd. v. Oakwood Petroleums Ltd. (1988), 72 C.B.R. (N.S.) 20 (Alta. Q.B.); Re NsC Diesel Power Inc. (1990), 70 C.B.R. (N.S.) 195 (B.C.C.A.).

316 Notes to pages 132-5 61 Re Canadian Airlines Corporation (2000), 19 C.B.R. (4th) 12, leave to appeal refused 29 May 2000. 62 Re Woodwards Ltd. (1993), 84 B.C.L.R. (2d) 206 (B.C.S.C.); Armbro Enterprises Inc. (1993), 22 C.B.R. (3d) 80 (Ont. Ct J. (Gen. Div.)). 63 Re Woodwards Ltd., supra, note 62. Michael Fitch, "Store Wars: The Saga of Woodwards' Reorganization,' in J. Ziegel and D. Baird, eds., Case Studies in Recent Canadian Insolvency Reorganizations, In Honour of the Honourable Lloyd W. Houlden (Scarborough: Carswell, 1997) at 535. 64 Re Armbro Enterprises Inc., supra, note 2. 65 Patrick O'Kelly, 'A Marriage of Convenience, the Mac's Milk Plan/ in Ziegel and Baird, Case Studies at 465, 488. 66 Royal Bank v. Fracmaster, Ltd. (7 June 1999), Court File No. 99-18326, 27, 31, 35 (Alta. C.A.). 67 Re Quintette Coal Ltd. (1992), 13 C.B.R. (3d) 146 (B.C.S.C.); Re Dairy Corporation of Canada, [1934] O.R. 436 (S.C.); Olympia & York Developments Ltd. v. Royal Trust Co. (1993), 17 C.B.R. (3d) 1 (Ont. Ct J. (Gen. Div.), Commercial List), Blair J. at 1. Re Northland Properties Ltd. (1988), 73 C.B.R. (N.S.) 175 at 182 (S.C.) aff'd 73 C.B.R.(N.S-) 195, 34 B.C.L.R. (2d) 122 (C.A.). 68 Re Canadian Airlines, supra, note 61. 69 Re Olympia & York, supra, note 1 at 1. 70 Algoma Steel Corporation v. Royal Bank (1992), 11 C.B.R. (3d) 1 (Ont. Ct (Gen. Div.)). Northland Properties Ltd. (1988), 73 C.B.R. (N.S.) 175 (B.C.S.C.), aff'd on appeal (1989), 73 C.B.R. (N.S.) 195 (B.C.C.A.) at 201; Campeau v. Olympia & York, supra, note 21. Quintette Coal Ltd. v. Nippon Steel Corp. (1990), 51 B.C.L.R. (2d) 105 (B.C.C.A.) at 116. 71 An exception might be where the court is persuaded that the plan is unethical. Ecole international de Haut Esthetique (1989), 78 C.B.R. (N.S.) 36 (C.s. Q.). 72 Re Olympia & York Developments, supra, note 1 at 1; see also Multidev Immobilia Inc. c. Societe Anonyme Just Invest (1988), 70 C.B.R. (N.S.) 91 (C.S.Q.). 73 Re Olympia & York Developments, supra, note 1 at 11. 74 Re Campeau Corporation (1992), 10 C.B.R. (3d) 104 (Ont. Ct J. (Gen. Div.)); Algoma Steel Corporation v. Royal Bank (1992), (O.J. No. 795 (Ont. Ct J. (Gen. Div.)). 75 Ecole internationale de Haute Esthetique Edith Serei Inc., supra, note 71 at 38. 76 Algoma Steel Corporation v. Royal Bank (1992), 11 C.B.R. (3d) 11, 8 O.R. (3d) 449, 55 O.A.C. 303 (Ont. C.A.), leave to appeal to S.C.C. refused (29 Oct. 1992).

Notes to pages 136-43 317 77 Re Olympia & York Developments, supra, note 1 at 1; Northland Properties Ltd., supra, note 70 at 205. 78 Honourable Justice G.R. Forsyth, 'Judicial Discretion under the CCAA,' in Corporate Restructurings and Insolvencies, at 88. 79 Consumers Packaging, supra, note 36. 80 PSINet, supra, note 34. 81 Menegon v. Philip Services Corp., [1999] O.J. No. 4080 (Ont. S.C.J. (Commercial List)). 82 Re Canadian Airlines, supra, note 61. 83 G. Triantis, 'Debt Financing, Corporate Decision Making and Security Design' (1995), 26 C.B.L.J. 93. 84 Re Blue Range Resources Corp. (1999), 12 C.B.R. (4th) 186 (Alta. C.A.); Cineplex Odeon Corp. (2001), 24 C.B.R. (4th) 201 (Ont. C.A.); Re Consumers Packaging Inc. (2001), 27 C.B.R. (4th) 197 (Ont. C.A.). 85 Re Country Style Food Services Inc., [2002] O.J. No. 1377 (Ont. C.A.). 86 Re Repap British Columbia, (7 Aug. 1998), B.C.J. No. 2041, Court File No. CAO24657 (B.C.S.C.); Re Repap British Columbia, [1998] B.C.J. No. 1068. 87 Hamilton and Wade, 'Restructuring under the CCAA.' 88 Another example is the Chancery Court as an effective business court in the United Kingdom, with its system of 'quick turn around,' promptness, and consistency. Celia Cohen, 'The Appeal of the Chancery Court/ American Lawyers' Law News Network (16 Mar. 1999). 89 R. McRae, 'Northland Properties Ltd./ in Ziegel and Baird, Case Studies, at 105. 90 Lorraine King, 'Wandlyn Inns Ltd.: A New Brunswick Restructuring/ in Ziegel and Baird, Case Studies, at 213. 91 Loewen Group Inc., in the matter of an application under the Companies' Creditors Arrangement Act, Order (1 June 1999), Court File No. 99-CL-3384 (Ont. S.C.J. Commercial List), Farley J. Case Management Conference, Oral Submissions of R. Sierry, Counsel for Loewen, citing statistics on the time taken in Chapter 11 proceedings (12 Aug. 1999). 92 The first practice direction was published in 1995 and revised in 2000; (2000) 15 Insolvency News 2. 93 Paul leVay, 'Commercial List Practice Direction/ CBAO Conference, Toronto, 1997, at 2. 94 Memorandum: Implementation of Revised Commercial List, dated 5 Nov. 1997. 95 Michael Kainer, interview, 20 July 1999. 96 Re Royal Oak Mines, supra, note 30 at paras. 27, 28. 97 Farley, The Judges Speak/ at 763.

318 Notes to pages 143-51 98 Re Skydome Corporation, supra, note 6. 99 Ss. 11.5,11.7, CCAA. 100 Re Ski/dome Corporation, supra, note 6. Endorsement (19 Feb. 1999) (Ont. Ct J. (Gen. Div.), Commercial List), Blair J., citing Soundair, supra, and Crown Trust Co. v. Rosenberg (1986), 60 O.K. (2d) 87 (Ont. Gen. Div.). 101 Re T. Eaton- Co., [1999] OJ. No. 4112 (Ont. S.CJ. (Commercial List)). 102 Morawetz, 'Canadian Version of DIP Financing.' 103 Re Laidlaw Inc., supra note 59 at paras. 2-9. 104 McCarthy, in Ziegel and Baird, Case Studies at 28. In Innisfil Landfill Corp. the Ontario Court declined to allow cross-examination of a receiver on the basis that no need was established and that the receiver as a court officer did not make reports in an affidavit form. Mortgage Insurance Co. of Canada v. Innisfil Landfill Corp., [1995] OJ. No. 32 (Ont. Ct (Gen. Div.)). 105 R. Jones and R. Dixon, 'Oakwood Petroleums Ltd.', in Ziegel and Baird, Case Studies, at 359. 106 Re: Consumers Packaging Inc. et al. (2001), Toronto File No. Ol-CL-4147 (Ont. S.C.); M. Forte, 'The Recognition and Roles of the Chief Restructuring Officer in Canadian Insolvency Proceedings' (2001) 14 Comm. Insolvency Review 4. 107 Myers and Sellers, 'Recognition of Social Stakeholders/ at 38. 108 Ibid, at 44. 109 Ibid, at 45. 110 CCFL Subordinated Debt Fund and Company Limited Partnership and MedChem Health Care Limited/ Soins de sante Med-Chem limitee, Court File No. 98-CL-3200 (Ont. C.J. (Gen. Div.)) ('Med-Chem'). 111 CCFL Subordinated Debt Fund Limited Partnership and Co. v. Med-Chem Health Care Ltd., unreported decision dated 4 Dec. 1998, Cans J. (Ont. Ct. (Gen. Div.) Commercial List). 112 Third Report of Receiver Med-Chem, supra, note 110 at para. 11. 113 The Honourable Lloyd W. Houlden, interview, 27 July 1999, quoted with permission. 114 Med-Chem, supra, note 110 at para. 16. 115 Ibid., Orders (19 Feb. 1999), (9 Mar. 1999), Cans J. 116 Ibid., Order (1 Feb. 1999), Cans J. at para. 2. 117 Receiver's Agreement Med-Chem, supra, note 110. 118 Order of Justice Cans dated 19 Feb. 1999 (the Sale Process Order). 119 Fourth Report of Receiver Med-Chem, supra, note 110 at para. 6. 120 Motion Record of the Landlord Group in the matter of Med-Chem Health Care Limited, Court File 98-CL-3200, dated 14 Apr. 1999. 121 Memorandum of Savage Walker Capital Inc., dated 8 Apr. 1999 at 1. Motion Record, 15 Apr. 1999.

Notes to pages 151-63 319 122 Soundair Corporation v. Royal Bank of Canada (1991), 7 C.B.R. (3d) 1 (Ont. C.A.); Re Canadian Red Cross Society, [2000] OJ. No. 3421 (S.C.J.). 123 Written Submissions Med-Chem, supra, note 110 at para. 4; F. Bennett, Bennett on Creditors' and Debtors' Rights and Remedies, 4th ed. (Scarborough: Carswell, 1994), citing Crown Trust Co. v. Rosenberg (1986), 60 O.K. (2d) 87 (H.C.) at 109. 124 Endorsement Med-Chem, supra, note 111 at para. 11. 125 CCFL Subordinated Debt Fund and Company, Limited Partnership and MedChem Health Care Limited/ Soins de sante Med-Chem limitee (16 Apr. 1999), Court File No. 31-OR-20647-T, Laskin J.A. 126 Myers and Sellers, "Recognition of Social Stakeholders,' at 72. 127 The Honourable Lloyd W. Houlden interview, supra, note 113. 5 Algoma Steel Corporation: Recognition of Human Capital Investments 1 Algoma Steel Corporation, Court File Doc. No. B62191-A (Ont. Ct (Gen. Div.)). 2 Re Algoma Steel Inc., [2001] OJ. No. 4630 (Ont. S.C.J.), Court File No. 01CL-4115; Endorsement Order, 19 Dec. 2001; Re Algoma Steel Inc., [2002] O. J. No. 66 (Ont. S.C.J. (Commercial List), Lesage CJ.S.C. 3 Steve Boniferro, executive vice-president Human Resources, Algoma Steel Inc., interviews, 11 June 1998, 2 Sept. 1999, and 21 Dec. 2001. 4 Jack Quarter, Crossing the Line: Unionized Employee Ownership and Investment Funds (Toronto: Lorimer & Company, 1995) at 112-13,118. 5 Kenneth Delaney, president and CEO, First Ontario Labour Sponsored Investment Fund, interviews, 11 June 1998 and 12 Sept. 1999. 6 James McCartney,'Algoma Steel Inc.: A Successful Restructuring/ in J. Ziegel and D. Baird, eds., Case Studies in Recent Canadian Insolvency Reorganizations (Scarborough: Carswell, 1997) at 234-5. 7 Algoma Steel Corporation v. Royal Bank of Canada (Trustee) (16 Apr. 1992), [1992] OJ. No. 795 (Ont. Ct J. (Gen. Div.)). 8 Mr Justice Farley, The Judges Speak,' in J. Ziegel, ed., Current Developments in International and Comparative Corporate Insolvency Law (Oxford: Oxford University Press, 1994) at 764. 9 McCartney, 'Algoma Steel Inc.' at 247; Quarter, Crossing the Line at 130. 10 Algoma Steel Inc. Notice of Proceedings and Meetings of Creditors and Information Circular, 10 Dec. 2001, http://www.algoma.com ('Information Circular'). 11 Quarter, Crossing the Line, at 126-8. 12 Boniferro interviews, supra, note 3; James Pearce, Supervisor, Labour Relations, Algoma Steel Corporation, interview, 28 Jan. 1999.

320 Notes to pages 163-9 13 The corporate articles specified that this joint governance will remain in place unless worker share ownership falls below 10 per cent; Memorandum of Agreement between Algoma Steel Inc. and USWA, 20 Dec. 1994, http://www.algoma.com. 14 Boniferro interviews, supra, note 3. 15 McCartney, 'Algoma Steel Inc.,' at 242-4. 16 Boniferro interviews, supra, note 3; Doug Olthius, Regional Director, USWA, interview, 21 Dec. 2001. 17 Quarter, Crossing the Line, at 122-3. 18 Information Circular, supra, note 10 at 14. 19 Ibid. 20 Monitor's Report, Re Algoma Steel Inc., [2001] O.J. No. 4630 (Ont. S.C.J.), Court File No. Ol-CL-4115. 21 Ibid., see also Information Circular, supra, note 10 at 20. 22 Algoma Steel Inc., Third Amended and Restated Plan of Arrangement and Reorganization, Pursuant to the CCAA and the OBCA, 10 Dec. 2001, Court File No. M27359 ('Algoma 2001 plan') at 9. 23 Ibid., Schedule C. 24 Ibid, at 22. 25 Ibid, at 14-15. S. 5.1 CCAA, specifies that compromises in respect of directors may not include claims that relate to contractual rights of one or more creditors, or claims based on allegations of misrepresentation or wrongful or oppressive conduct. 26 Algoma 2001 plan, supra, note 22 at 18, Schedule B; Press Release, United Steelworkers of America, 19 Dec. 2001, www.newswire.ca/releases/ December2001; Memorandum of Agreement between Algoma Steel Inc. and the United Steelworkers of America and its Local 2251,17 Dec. 2001, on file with author (Memorandum of Agreement) at 1. 27 Algoma 2001 plan, supra, note 22; Memorandum of Agreement, supra, note 26; Hugh MacKenzie, National Research Director, USWA, interview, 21 Dec. 2001. 28 Affidavit, Hap Stephen, CRO, Algoma Steel Inc., Motion Record, 19 Dec. 2001 (Ont. S.C.J.), Court File No. Ol-CL-4115. 29 Algoma 2001 plan, supra, note 22 at 11. 30 G. Triantis and R. Daniels, The Role of Debt in Interactive Corporate Governance' (1985), 83 Cal. Law Review 1073; M. Jensen and W. Meckling, Theory of the Firm: Managerial Behaviour, Agency Cost and Ownership Structure' (1976), 3 Journal of Fin. Econ. 305; B. Adler, 'An Equity-Agency Solution to the Bankruptcy-Priority Puzzle' (1993) J. of Legal Studies 73.

Notes to pages 170-85 321 31 32 33 34 35 36 37 38 39 40 41

Triantis and Daniels, 'Role of Debt/ at 1083-4. Algoma 2001 plan, supra, note 22, Schedule B. Memorandum of Agreement, supra, note 26 at 3. Ibid, at 5. Interview, Steve Boniferro, vice-president Algoma Steel, 21 Dec. 2001. Memorandum of Agreement, supra, note 26 at 15. Hugh MacKenzie, Director of National Research USWA, comments, 27 June 2002. Ibid. Court Order, 9 Nov. 2001, Re Algoma Steel Inv. Court File No. Ol-CL-4115 (Ont. S.C.J.). McCartney, 'Algoma Steel Inc.,' at 247. Olthius interview, supra, note 16.

6 Judicial Recognition of 'Social Stakeholders' in CCAA Proceedings: Anvil Range Mining Corporation 1 In the Matter of Anvil Range Mining Corporation and an application under the CCAA, Ontario Court File No. 98-BK-001268 (Ont. Ct J. (Gen. Div.), Commercial List); Endorsement (20 Aug. 1998), Blair J., at 2. 2 Anvil Range, supra, note 1, Submissions, Counsel for Yukon Territorial Government, Aug. 1998. 3 Frederick Myers and Edward Sellers, 'Recognition of Social Stakeholders in Canadian Insolvency Proceedings/ (1999) 11 Commercial Insolvency Reporter 6 at 68. 4 R. v. Curragh Inc., (7 May 1994), (Ont. Gen. Div. Commercial List), Farley J. 5 Myers and Sellers, 'Recognition of Social Stakeholders/ at 68. 6 Ibid. 7 Anvil Range, supra, note 1, Report of the Monitor (8 Apr. 1998); Stay Orders (11 Feb. 1998) and (18 Feb. 1998). 8 Submissions by Counsel for the Yukon Territorial Government in Anvil Range, supra, note 1; Factum of the Yukon Territorial Government (8 Apr. 1998) at 2. 9 Anvil Range, supra, note 1, Factum of the Yukon Energy Corporation (20 Apr. 1998). 10 Michael Kainer, interviews, 7 May 1998, and 21 June 2000; Paula Turtle, Legal Services, USWA, interview (29 Oct. 1998). 11 Supplementary Factum of the Yukon Territorial Government, Anvil Range, supra, note 1, 9 Apr. 1998.

322 Notes to pages 186-93 12 Report of the Monitor, Anvil Range, supra, note 1, at 6. 13 Supplementary Factnm, Yukon Territorial Government, Anvil Range, supra, note 1, at 3. 14 Factnm Yukon Territorial Government, Anvil Range, supra, note 1, at 10. 15 Submissions of James Grout for certain lien claimants, Anvil Range, supra, note 1. 16 Factum, Anvil Range, supra, note 1, at 10. 17 Anvil Range, supra, note 1, Endorsement (20 Aug. 1998), Blair J., at 2. 18 Grout submissions, Anvil Range, supra, note 15. 19 Ibid. 20 Michael Kainer, Counsel for USWA, oral argument on the sale of asset motion. Aug. 1998. 21 Ibid. Oral Submissions to the Court, Fred Myers, Counsel for Yukon Territorial Government, August 1998; Interim Receiver's Report, 14 Aug. 1998. 22 Interim receiver, Anvil Range, supra, note 1, figures given to the court hearing on motion for sale of assets. 23 Myers and Sellers, 'Recognition of Social Stakeholders.' 24 Endorsement, Anvil Range, supra, note 1, at 2. 25 Ibid. 26 Ibid, at 5. 27 Skydome Corporation, Endorsement (27 Nov. 1998) (Ont. Ct J. (Gen. Div.), Commercial List), Blair J. 28 Enterprise Capital Management Inc. v. Semi-Tech Corporation (5 May 1999) (Ont. S.C.J. Commercial List), Ground, J. at paras. 21, 22. 29 Royal Bank v. Fracmaster Ltd. (7 June 1999), Court File No. 99-18326, 27, 31, 35 (Alta. C.A.) at paras. 36, 40. 30 Re Starcom (17 Nov. 1998) (B.C.S.C.), Sanders J. 31 Anvil Range, supra, note 1, Factnm, YTG (8 Apr. 1998) at 5. 32 Anvil Range, supra, note 1, c. 6, Endorsement (29 July 1998) Blair J. 33 Edward Sellers, Counsel for YTG, telephone interviews, 17 Aug. 1999 and 4 June 2001. 34 Ibid. 35 Re Anvil Range Mining Corporation, [2001] O.J. No. 1453 (S.C.J.), appeal dismissed [2002] O.J. No. 2606 (Ont. C.A.). 36 Ibid., at para. 10. 37 The court also dismissed the argument that Anvil's interest in a mine in Greece was not taken into account in the valuing, the court finding that Anvil had no such interest. Re Anvil Range Mining Corporation, [2001] O.J.

Notes to pages 194-203 323 No. 4148 (C.A.), appeal from judgment dated 30 Dec. 1999 (S.C.J.) dismissed. 38 Re Anvil Range Mining Corporation, [2002] O.J. No. 2606 (Ont. C.A.) at paras. 8 and 32. 7 Competing Public Interest Considerations: Canadian Red Cross Society 1 Re Canadian Red Cross Society, [2000] O.J. No. 3421 (S.C.J.). 2 In the Matter of the Companies' Creditors Arrangement Act, Canadian Red Cross/La societe canadienne de la croix-rouge, (Ont. S.C.J.), Court File No. 98-CL-002970. Endorsement (19 Aug. 1998), Blair J. 3 Mr Justice Horace Krever, Commission of Inquiry on the Blood System in Canada, Final Report (Ottawa: Government of Canada), Part IV at 1030. 4 Red Cross, supra, note 2, Initial Order (20 July 1998), Blair J. at 2. 5 Ibid., at 9-10. 6 National Blood Program Acquisition Agreement, Red Cross, supra, note 2. 7 Krever, Commission of Inquiry, at 1030,1044. 8 Red Cross, supra, note 2, Endorsement (31 July 1998), Blair, J. at 2. 9 Ibid. 10 Red Cross, supra, note 2, Endorsement (19 Aug. 1999), Blair J. at para. 21. 11 Supported by a group of B.C. pre-1986/post-1990 HCV claimants, ibid, at paras. 23, 24. 12 Ibid., at para. 34. 13 The court in Red Cross applied the tests set out in Soundair Corporation v. Royal Bank of Canada (1991), 7 C.B.R. (3d) 1 (Ont. C.A.) at 6, specifically, was a sufficient effort made to get the best price and the actions were not improvident; was it in the best interests of all parties; was there efficacy and integrity in the process; and was there any unfairness in working out the proposal. Ibid, at paras. 16,18, 30. 14 Re Fracmaster Ltd. (17 May 1999), Docket Calgary 9901-05042 (Alta. Q.B.), Paperny, J., aff'd Royal Bank v. Fracmaster Ltd. (7 June 1999), Docket Calgary 99-18326-7,18331,18335 (Alta. C.A.), at paras. 18-23. 15 Schmidt v. Air Products Canada Ltd., [1994] 2 S.C.R. 611. 16 Red Cross, supra, note 2, Endorsement (21 Aug. 1998), Blair, J. 17 There were two additional escrow funds: $36 million for real property adjustments and $10 million to deal with residual transfer issues. Red Cross, supra, note 2, Order (6 Nov. 1998), Blair, J. 18 Red Cross, ibid., Notice of Motion, Procedure of Potential Pension Claims, at para. 3.

324 Notes to pages 204-11 19 Pay Equity Act, S.0.1988, c. P.16, as amended. Red Cross, supra, note 2, Motion Record, Service Employees International Union (28 July 1999). 20 Re Canadian Red Cross Society, [1999] OJ. No. 3657 (S.C.J.). 21 Michael Kainer, Counsel for Service Employees International Union in the Red Cross CCAA proceedings, interview, 20 July 1999, quoted with permission. 22 Red Cross, supra, note 2, Endorsement (18 Jan. 1999), Blair, J. 23 Brian Empey, Counsel for Red Cross, interviews, 23 June 1999 and 23 June 2001. This was because the costs of defence proceedings were to be borne by the insurer and thus would not come from the assets. 24 Red Cross, supra, note 2, Endorsement (26 Apr. 1999), Blair, J., at 6. 25 Red Cross Proposed Plan of Arrangement, 29 Mar. 1999, Red Cross, supra, note 2. 26 Ibid, at para. 5. 27 Class Counsel Statement to Announce Details of Hepatitis C January 1, 1986 to July 1, 1990 Class Actions Settlement (15 June 1999) at 1, cited to class action web site, http://www.hepc8690.ca/ 28 Bonnie Tough, Class Counsel for the Hemophiliac Action, interview, 26 July 1999. 29 Parsons v. The Canadian Red Cross Society (1999), 40 C.P.C. (4th) 151 (Ont. S.C.J.); Endean v. Canadian Red Cross Society (1999), 68 B.C.L.R. (3d) 350 (B.C.S.C.). 30 Ibid., at para. 10. 31 The claims of secured creditors were satisfied by the asset sale or are in the process of being satisfied and thus there are no outstanding secured creditor claims. Empey interviews, supra, note 23. 32 Re Canadian Red Cross Society, [2000] OJ. No. 3421 (S.C.J.), at para. 23. 33 Ibid, at para. 6. 34 Ibid, at para. 20. 35 Ibid, at para. 28. 36 McCarthy v. Canadian Red Cross Society, [2001] OJ. No. 567 (S.C.J.). 37 Ibid. 38 Killough v. Canadian Red Cross Society, [2001] B.CJ. No. 1481 (B.C.S.C.), at para. 20; McCarthy v. Canadian Red Cross Society, [2001] OJ. No. 2474 (S.C.J.) at paras. 15-17. 39 Killough, supra, note 38, at para. 20. 40 Ibid. 41 Surprenant c. Societe canadienne de la Croix-Rouge, [2001] J. Q. No. 3717 (C. s. Q.).

Notes to pages 212-17 325 42 G.M. Cole, 'A Calculus Without Consent: Mass Tort Bankruptcies, Future Claimants and the Problem of Third Party Non-Debtor Discharge' (1999) 84 Iowa Law Review 753. 43 Parsons v. Canadian Red Cross Society (2000), 49 O.R. (3d) 281 (S.CJ.) at para. 71; McCarthy v. Canadian Red Cross Society, [2001] OJ. No. 2474 (S.C.J.). 44 Kainer interview, supra, note 21. 45 Re Diana Louise Parsons et al. and the Canadian Red Cross et al. judgment dated 11 July 2002, Court File No. 98-CV-141369CV (Ont. S.C.J.); Re Anita Endean, Representative Plaintiff and Canadian Red Cross et al., judgment dated 12 July 2002, Court Docket C965349 (B.C.S.C.); Dominique Honhon c. Societe Canadienne de la Croix-Rouge et al., 11 juillet 2002, Dossier No. 50006-000016-960 (C.s.Q.). 46 2001 Annual Report, Hepatitis C January 1,1986-July 1,1990 Class Action Settlement Trust Fund, http://www.hepc8690.ca/content/annualReport/ 2001. 47 2001 Annual Report, Hepatitis C January 1,1986-July 1,1990 Class Action Settlement Trust Fund, http://www.hepc8690.ca/content/annualReport/ 2001. The report specifies that this amount will be similar in year two as the volume of appeals increases. No amounts are paid to fund counsel without a court order. 48 Re Canadian Red Cross Society, [2002] O.J. No. 2567 (Ont. S.C.J.). 49 Re Canadian Red Cross Society, [2002] O.J. No. 4326 (Ont. S.C.J.); S. 38, Trustee Act, R.S.O. 1990, c. T. 23. 8 Canadian Airlines Corporation and the Public Interest 1 Re Canadian Airlines Corp., [2000] A.J. No. 771 (Alta. Q.B.) 95, application for leave to appeal dismissed, Resurgence Asset Management LLC v. Canadian Airlines Corporation [2000] A.J. No. 1028 (Alta. C.A.); appeal dismissed [2000] A.J. No. 1634 (Alta. C.A.); application for leave to appeal dismissed, [2001] S.C.C.A. No. 60 (S.C.C.). 2 See for example, Re Canadian Airlines Corp., [2001] A.J. No. 226 (Alta. Q.B.); Re Canadian Airlines Corp., [2000] A.J. No. 1321 (Alta. Q.B.); Ontario v. Canadian Airlines Corp., [2001] A.J. No. 1457 (Alta. Q.B.); Norm McPhedran, 'Canadian Airlines - The Last Tango in Calgary: Key Issues Faced by the Monitor' (Toronto: The Insolvency Institute of Canada, 2000), and Geoffrey Morawetz, 'Controversial Legal Rulings, Canadian Airlines - The Last Tango in Calgary' (Toronto: The Insolvency Institute of Canada, 2000) (http://www.Carswell.insolvencypro).

326 Notes to pages 218-31 3 Re Canadian Airlines Corp., supra, note 1, at para. 20. 4 Sean Dunphy, 'Canadian Airlines - The Last Tango in Calgary, Air Canada's Perspective' (Toronto: The Insolvency Institute of Canada, 2000) at 12 (http://www.Carswell.insolvencypro). 5 Re Canadian Airlines Corp., supra, note 1, at para. 11. 6 Ibid., at para. 27. 7 Ibid., at paras. 29-33. 8 Ibid., at para. 45. 9 Orders of Madame Justice Paperny dated 14 April and 10 May 2000, cited in Resurgence Asset Management LLC v. Canadian Airlines Corp., [2000] A.J. No. 1028 (Alta. C.A.). 10 Dunphy, 'Canadian Airlines/ at 9. 11 Re Canadian Airlines Corp., supra, note 1, at para. 50. 12 Ibid, at para. 51. 13 Dunphy, 'Canadian Airlines,' at 18. 14 Resurgence Asset Management LLC v. Canadian Airlines Corp., supra, note 9. 15 Patrick McCarthy, 'Unique Issues, Canadian Airlines - The Last Tango in Calgary' (Toronto: The Insolvency Institute of Canada, 2000) (http://www.Carswell.insolvencypro), at 25. 16 Dunphy, 'Canadian Airlines,' at 14. 17 Re Canadian Airlines Corp., supra, note 1, at para. 103. 18 Ibid., at paras. 105, 106, 157. 19 For a more fulsome discussion of the voting issues, see Morawetz, 'Controversial Legal Rulings,' at 31-3. 20 Re Canadian Airlines Corp., supra, note 1, at para. 140. 21 Ss. 167, 185, Alberta Business Corporations Act, S.A. 1981, c. B-15, as amended. 22 Dunphy, 'Canadian Airlines,' at 20. 23 Resurgence Asset Management LLC v. Canadian Airlines Corp., supra, note 9. 24 Re Canadian Airlines Corp., supra, note 1, at para. 144. 25 Ibid., at para. 175. 9 International Comparisons: Creditor Rights and the Public Interest 1 Ian Fletcher, Insolvency in Private International Law (Oxford: Clarendon Press, 1999); David Skeel, Debt's Dominion: A History of Bankruptcy Law in America (Princeton: Princeton University Press, 2001); Michelle White, 'The Costs of Bankruptcy: A U.S.-European Comparison/ in J.S. Bhandari and L. A. Weiss, eds., Corporate Bankruptcy: Economic and Legal Perspectives (Cambridge: Cambridge University Press, 1996); Julian Franks and Walter

Notes to pages 232-5 327

2 3

4

5 6 7 8

9 10 11

12

13 14

Torous, 'Lessons from a Comparison of U.S. and U.K. Insolvency Codes/ in ibid.; M. Kissane, 'Global Gadflies: Applications and Implications of U.S. Style Corporate Governance Abroad' (1997) 17 N.Y. Sch. J. of International and Comparative Law 621; Jacob Ziegel, ed., Current Developments in International and Comparative Corporate Insolvency Law (Oxford: Clarendon Press, 1994); G. Triantis and L. LoPucki, 'A Systems Approach to Comparing U.S. and Canadian Reorganization of Financially Distressed Corporations/ in Ziegel, Current Developments, at 109; Paul Omar, The Landscape of International Insolvency Law' (2002) 11 International Insolvency Review 173. Ss. 363,1121(b), (c), U.S. Bankruptcy Code. Elizabeth Warren and Jay Westbrook, The Law of Debtors and Creditors: Texts, Cases and Problems, 4th ed. (Gaithensburg, NY: Aspen Law and Business, 2001) at 399. E. Warren, The Untenable Case for Repeal of Chapter 11' (1992) 102 Yale Law Journal 437 at 443. Lynn Lopucki and William Whitford, 'Venue Choice and Forum Shopping in Bankruptcy Reorganization of Large Publicly Held Companies' (1991) Wis. L. Rev. 411; Hon. E.H. Jones, 'Chapter 11: A Death Penalty for Debtor and Creditor Interests' (1992) 77 Cornell L. Rev. 1089. Skeel, Debt's Dominion, at 3,17, 61, 80. Warren and Westbrook, The Law of Debtors and Creditors, at 396-7. Ibid, at 593-4. Warren, 'Untenable Case for Repeal/ at 469-70. R.J. Mann, 'Bankruptcy and the Entitlements of Government: Whose Money Is It Anyway?' (1993) 70 N.Y.U.L.R. 993. Karen Gross, 'On the Merits: A Response to Professors Girth and White' (1999) American Bankruptcy Law Journal 485 at 489. Anna Chou, 'Corporate Governance in Chapter II: Electing a New Board' (1991) 65 Am. Bank. L.J. 559 at 571. Bruce Markell, 'Owners, Auctions and Absolute Priority in Bankruptcy Reorganizations' (1991) 44 Stanford Law Review 69 at 69-72. Thus two claims of the same priority can receive different amounts. Ibid, at 576. T. Sullivan and J. Westbrook, The Persistence of Local Legal Culture: Twenty Years of Evidence from the Federal Bankruptcy Courts' (1994) 17 Harv. J. of Law and Social Policy 801 at 806; Elizabeth Warren, 'Why Have a Federal Bankruptcy System?' (1992) 77 Cornell L. Rev. 1093. Skeel, Debt's Dominion, at 215-16. L. Lopucki, 'A General Theory of the Dynamics of State Remedies Bankruptcy System' (1982) Wise. Law Review 311 at 311.

328 Notes to pages 235-42 15 S. 1129, Bankruptcy Code. 16 S. 1129, Bankruptcy Code; Markell, 'Owners, Auctions and Absolute Priority,' at 111. 17 T. Eisenberg and L. LoPucki, 'Shopping for Judges: An Empirical Analysis of Venue Choices in Large Chapter 11 Reorganizations' (1999) 84 Cornell Law Review 967 at 979. 18 National Bankruptcy Review Commission, Bankruptcy Reform Act of'1994, Pub. L. No. 103-394,108 Stat. Ss. 601-10 (1997). 19 Skeel, Debt's Dominion, at 197. 20 Richard Koral and Marie-Christine Sordino, The New Bankruptcy Reorganization Law in France: Ten Years Later' (1996) 70 American Bankruptcy Law Journal 437. 21 Maitre Planchard, Tribunal de Commerce, Montpellier, France, interview, 6 July 2000. 22 Kissane, 'Global Gadflies,' at 646. 23 White, 'Costs of Bankruptcy,' at 444-6. 24 Isabelle Didier, 'Mediation, A French Example' (2002) Insol World 8. 25 White, 'Costs of Bankruptcy,' at 448. 26 $4 million in 1996 U.S. dollars. Koral and Sordino, 'New Bankruptcy Reorganization Law/ at 449. 27 Ibid, at 450. 28 Geyer v. Ingersoll Publications Co., 621 A. 2d 784 (Del. Ch. 1992); Ben Franklin Retail Stores, 2000 U.S. Dist. Lexis 11; Re Healthco, 208 B.R. 300; Odyssey Partners, 735 A.2d 417; Stephen McDonnell, 'Geyer v. Ingersoll Publications Co: Insolvency Shifts Directors' Burden from Shareholders to Creditors' (1994) 19 Del. J. Corp. L. 177; B. Nicholson, 'Recent Delaware Case Law Regarding Directors' Duties to Bondholders' (1994) 19 Del. J. Corp. L. 573; C. Barnett, 'Healthco and the "Insolvency Exception": An Unnecessary Expansion of the Doctrine?' (2000) 16 Bankr. Dev. J. 441; Laura Lin, 'Shift of Fiduciary Duty on Corporate Insolvency: Proper Scope of Directors' Duty to Creditors' (1993) 46 Vanderbilt Law Review 1485; Credit Lyonnais Bank Nederland v. Pathe Communications Corp. (1991) Del. Ch. Lexis (108-9). 29 Gross, 'On the Merits.' 30 Bruce Markell, 'Changes in Attitudes, Changes in Platitudes: A Short Examination of Non-Uniform Approaches to Business Insolvency' (1998) Am. Bank. Inst. L. Rev. 35 at 45. 31 Marjorie Girth, 'Rethinking Fairness in Bankruptcy Proceedings' (1999) American Bankruptcy Law Journal 449.

Notes to pages 242-6 329 32 See for example, Re Marin Town Center, 142 B.R. 374 (N.D. Cal. 1992); Figter Ltd. v. Teachers Insurance and Annuity Association of America, 118 F.3d 635 (9th Cir. 1997), cert, denied, 118 S. Ct. 561 (1997). 33 Girth, 'Rethinking Fairness.' 34 Koral and Sordino, 'New Bankruptcy Reorganization Law,' at 442. 35 Ibid, at 444, 453. 36 S. Spracker and J. Barnette, 'The Treatment of Environmental Matters in Bankruptcy Cases' (1995) 11 Bank. Dev. J. 85 at 91,126. 37 Franks and Torous, 'Lessons from a Comparison of U.S. and U.K. Insolvency Codes,' at 461-3. 38 Re Chicago, Milwaukee, St. Paul & Pacific Railway Company, 830 F. 2d 758 (7th Cir. 1989); Palmer v. Mass, 308 U.S.79 (1939); Re Delaware and Hudson Ry. Company, 124 B. R. 169 (D. Del. 1991); Re Boston and Main Corp., 719 F. 2d 493 (1st Cir. 1983). 39 Julie Veach, 'On Considering the Public Interest in Bankruptcy: Looking to the Railroads for Answers' (1997) 72 Ind. L.J. 1211. 40 Karen Gross, Failure and Forgiveness: Rebalancing the Bankruptcy System (New Haven: Yale University Press, 1997) and the cases cited therein. 41 Ibid. 42 Girth, 'Rethinking Fairness,' at 467. 43 Re Johns-Manville Corporation, 36 B.R. 743, 747 (Bankr. S.D.N.Y. 1984), aff'd 700 F. 2nd 581 (1990); Re Amatex Corporation, 755 F. 2d. 1034,1042 (3d. Cir. 1985); Re A.M. Robbins Co., 88 B.R. 742 (E.D.Va. 1988); Re Dow Corning Corp., 37 Collier Bankr. Cases 2d. 1659 (6th Cir. Mich. 1997). 44 E.H. Jones, 'Rough Justice in Mass Future Claims: Should Bankruptcy Courts Direct Tort Reform?' (1998) 76 Texas Law Review 1695; J. Coffee, 'Class Wars: The Dilemma of the Mass Tort Class Action' (1995) 95 Columbia Law Review 846; Richard Sobol, Bending the Law: The Story of the Dalkon Shield Bankruptcy (Chicago: University of Chicago Press, 1991). 45 11 U.S.C. ss. 524(g), (h). 46 Michelle White, 'Why the Asbestos Genie Won't Stay in the Bankruptcy Bottle' (2002, http://weber.ucsd.edu/~miwhite). 47 Ibid. 48 G.M. Cole, 'A Calculus Without Consent: Mass Tort Bankruptcies, Future Claimants and the Problem of Third Party Non-Debtor Discharge' (1999) 84 Iowa Law Review 753; Sobol, Bending the Law. 49 White, 'Asbestos Genie/ at 17. Michelle White, 'Asbestos Litigation: The Role of Procedural Innovations in Mass Tort' (2002, http: / / weber. ucsd.edu / -miwhite).

330 Notes to pages 247-52 50 Ibid, at 6-7. 51 Re NLRB v. Bildisco and Bildisco, 465 U.S. 513 (1984); 104 S. Ct. 1188 (1984). 52 11 U.S.C. s. 1113 (1984), enacted as part of the Bankruptcy Amendments and Federal Judgeship Act of 1984, Pub. L. No. 98-353, 98 Stat. 333 (1984); C.J. Cuevas, 'Necessary Modifications and Section 1113 of the Bankruptcy Code: A search for the Substantive Standard for Modification of a Collective Bargaining Agreement in Corporate Reorganizations' (1990) 64 Am. Bank L.J. 133 at 224. 53 Century Brass Products Inc., v. International Union of Automobile, Aerospace and Agricultural Implement Workers, 795 F. 2d 265 (2d Circuit), cert, denied, 497 U.S. 949 (1986). 54 M. Kirschner, W. Goldsmith, L. Gottesman, D. Jenab, and J. Swardenski, Tossing the Coin under Section 1113: Heads or Tails, the Union Wins' (1993) 23 Seaton Hall Law Review 1516 at 1544. 55 Sheet Metal Workers International Association v. Mile Hi Metal Sys. Inc., 899 F. 2d 887 (10th Cir. 1990); Re Maxwell Newspapers Inc. (MM), 981 F. 2d Cir. (1992) at 89. See also Re Royal Composing Room Inc. 848 F. 2d at 343 (2d Cir. 1988), cert, denied 489 U.S. 1078 (1989); Carey Transport v. Teamsters, 816 F. 2d 82 (2d Cir. 1987); Re Salt Creek Freightways, 46 Bankr. R. 347 (Bankr. D. Wyo. 1985). 56 Anne McClain, 'Bankruptcy Code Section 1113 and the Simple Rejection of Collective Bargaining Agreements: Labor Losses Again' (1991) 80 Geo. Law Journal 191 at 191-3. 57 Royal Composing, supra, note 55 at 348; MRI, 981 F. 2d 85 (2d. Cir. 1992) at 90, 92. However, the fact that the union has agreed to cut may not be sufficient to defeat a repudiation application, Zn Re Valley Steel Prod. Co., 142 B.R. 337 (Bankr. E. D. Mo. 1992) at 342. 58 Manville Corporation v. Equity Security Holders Comm., 52 B.R. 879, 885 (Bankr. S.D.N.Y. 1985), aff'd 60 B.R. 841 (S.D.N.Y.) rev'd 801 F. 2d. 60 (2d. Cir.) on remand 66 B.R. 517 (Bankr. S.D.N.Y. 1986). Harvey Miller, 'Corporate Governance in Chapter II: The Fiduciary Relationship Between Directors and Stockholders of Solvent and Insolvent Corporations' (1993) 23 Seton Hall Law Rev. 1476. 59 Northwest Bank Worthington v. Ahlers, 485 U.S. 197,108 S.Ct. 963 (1988). 60 White, 'Costs of Bankruptcy,' at 469-71. 61 Ibid, at 444. 62 S. 1129(b), Bankruptcy Code. 63 Miller, 'Corporate Governance in Chapter 11,' at 1492. Bruce Markell, 'Clueless on Classification: Toward Removing Artificial Limits on Chapter 11 Claim Classification' (1995) 11 Bank. Dev. J. 2 at 46.

Notes to pages 252-6 331 64 Douglas Baird and Thomas Jackson, 'Bargaining after the Fall and the Contours of the Absolute Priority Rule' (1988) 55 U. Chi. L. Rev. 738 at 738-40. 65 L. Bebchuk and J. Fried, The Uneasy Case for Priority of Secured Claims in Bankruptcy' (1996) 105 Yale L.J. 857 at 934. See also B. Adler, 'An Equity-Agency Solution to the Bankruptcy Priority Puzzle' (1993) 22 J. Legal Studies 73 at 93. 66 Franks and Torous, 'Lessons,' at 461; L. Weiss, 'Bankruptcy Resolution: Direct Costs and Violation of Absolute Priority' (1990) 27 Journal of Financial Economics 285; L. LoPucki and W. Whitford, 'Corporate Governance in the Bankruptcy Reorganization of Large, Publicly Held Companies' (1993) 141 U. Pa. Law Review 669. 67 Lin, 'Shift of Fiduciary Duty/ at 1512. See also J. Coffee and W. Klein, 'Bondholder Coercion: The Problem of Constrained Choice in Debt Tender Offers and Recapitalizations' (1991) 58 U. Ch. L. R. 1207. 68 Lin, 'Shift of Fiduciary Duty,' at 1513,1518,1521 and the cases cited therein. 69 Credit Lyonnais Bank Nederland N.V. v. Pathe Communications Corporation, CIV A 12150,1991, WL277613 (Del. Ch. 30 Dec. 1991); R. Nimmer and R. Feinberg, 'Chapter 11 Business Governance, Fiduciary Duties, Business Judgment, Trustees and Exclusivity' (1989) 6 Bank. Dev. J. 1 at 82. 70 Lin, 'Shift of Fiduciary Duty,' at 1504-5, citing s. 510 of the Bankruptcy Code. 71 Miller,'Corporate Governance in Chapter 11,'at 1469,1507. M. Bienenstock, 'Conflicts Between Management and the Debtor in Possession's Fiduciary Duties' (1992) 61 Cinn. L. Rev. 543; Christopher Frost, 'Bankruptcy Redistribution Policy and the Limits of Judicial Process' (1995) 74 N.C. Law Rev. 75 at 119. 72 Frost, 'Bankruptcy Redistribution Policy,' at 119-20,135. 73 Koral and Sordino, 'New Bankruptcy Reorganization Law,' at 441; White, 'Costs of Bankruptcy,' at 476. 74 White, 'Costs of Bankruptcy/ at 451. 75 Ibid, at 478. 76 Koral and Sordino, 'New Bankruptcy Reorganization Law/ at 453. 77 In 1986 there were over 70,000 claims under this fund and workers could receive a maximum of £2,156 ($3,780 Cdn.) for wages and vacation and up to £1,848 ($3,240 Cdn.) in severance pay. J. Ziegel et al., Secured Transactions in Personal Property, Suretyships and Insolvency, Volume III, Cases, Text and Materials (Toronto: Emond Montgomery, 1995) at 734. 78 Council Regulation (EC) No. 1346/2000, in force 31 May 2002.

332 Notes to pages 257-62 79 T. Hoshi, A. Kashyap, and D. Scharfstein, 'The Role of Banks in reducing the Cost of Financial Distress in Japan/ in Bhandari and Weiss, Corporate Bankruptcy: Economic and Legal Perspectives, at 531. 80 Klaus Kamlah, The New German Insolvency Act: Insolvenzordnung' (1996) 70 American Bankruptcy Law Journal 417. 81 Ibid, at 421. 82 Christof Schiller, Three Years of Insolvency Plans in Germany' (2002) 2 Eurofenix 4. 83 Kamlah, 'New German Insolvency Act,' at 424. 84 Schiller, Three Years of Insolvency Plans,' at 4. 85 Ibid. 86 Kamlah, 'New German Insolvency Act,' at 427. 87 Schiller, Three Years of Insolvency Plans.' 88 Ibid. 89 For a discussion of this see White, 'Costs of Bankruptcy,' at 467. 90 Kamlah, 'New German Insolvency Act,' at 429. 91 Ibid, at 431-2. 92 Ibid, at 423. 93 Schiller, Three Years of Insolvency Plans.' 94 Kamlah, 'New German Insolvency Act,' at 429-30. 95 Schiller, Three Years of Insolvency Plans/ at 5. 96 Ibid, at 5. 97 Ibid. 98 White, 'Costs of Bankruptcy/ at 471. 99 Kissane, 'Global Gadflies/ at 650. 100 Kamlah, 'New German Insolvency Act/ at 420. 101 Franks and Torous, 'Lessons/ at 450, 454. 102 Ibid, at 460-4. 103 Review of the Insolvency Law Review Committee, Insolvency Law and Practice, Cmnd 8558 (1982) (the 'Cork Report') at para. 204. 104 Ibid, at para. 204. 105 Harry Rajak, The Challenge of Commercial Reorganization in Insolvency: Empirical Evidence from England/ in Ziegel, Current Developments, at 191,194,199-200, 212. 106 Andrew Keay, 'Insolvency Law: A Matter of Public Interest' (2000) 51 Northern Ireland Legal Quarterly 509 at 518. 107 Ibid, at 510-15; see also Ian Fletcher, 'Juggling with Norms: the Conflict Between Collective and Individual Rights under Insolvency Law/ in R. Cranston, ed., Making Commercial Law: Essays in Honour of Roy Goode (Oxford: Clarendon Press, 1997) at 391-417.

Notes to pages 262-71 333 108 Rajak, 'Challenge of Commercial Reorganization/ at 195. 109 In this respect, the administrator acquires power and control just as liquidators and receivers do under the regime. Franks and Torous, 'Lessons,' at 459. 110 Ibid. 111 Franks and Torous, 'Lessons/ at 479. 112 Ibid, at 456. 113 Ibid, at 457. The difficulty of course is how one values going concern value. White, 'Costs of Bankruptcy/ at 470. 114 From 1986 to 1991 more than a thousand directors were disqualified. Ibid, at 456. 115 Insolvency Act 2000, effective 1 Jan. 2003. 116 Franks and Torous, 'Lessons/ at 460. 117 Rajack, 'Challenge of Commercial Reorganization/ at 207-10. 118 White, 'Costs of Bankruptcy/ at 462. 119 Rajak, 'Challenge of Commercial Reorganization/ at 211, citing s. 80(3)(d), Insolvency Act. 120 Ibid, at 195; White, 'Costs of Bankruptcy/ at 476. Over 50 per cent of filings in 1987 were blocked by secured creditors in this way. 121 Rajak, 'Challenge of Commercial Reorganization/ at 195, and the cases cited therein. 122 M. Wong and N. Rose, 'Debtor-in-Possession Financing' (2002) Insol World 3. 123 Keay, 'Insolvency Law/ at 530. 124 Ibid, at 530-3. 125 Ibid, at 533. 126 Insolvency Act 2000, http://legislation.hmso.gov.uk/stat.htm; http:// www.insolvency.gov.uk/newsmallcompanyrescue.htm. 127 Enterprise Act 2002, http://www.legislation.hsmo.gov.uk/acts/acts2002/ 20040--r.htm. Lorraine Clover, 'U.K. Proposed Reforms' (2002) 2 Eurofenix 7. 128 Wong and Rose, 'Debtor-in-Possession Financing/ at 3. 129 Ibid.; Enterprise Act 2002, at s. 251. 130 Reg. 1346/2000; see also Gabriel Moss, The Impact of the EU Regulation on UK Insolvency Proceedings' (2002) 11 International Insolvency Review 139. 131 J. Willcock, 'Are You Ready for European Bankruptcy Regulation?' (2002) Insol World 2. 132 Jean-Luc Vallens, 'Regulation 1346/2000 on Insolvency Proceedings, Its Application in France' (Strasbourg: University Robert-Schuman, 2001) at 7.

334 Notes to pages 271-7 10 Conclusion: Future Development of the Public Interest within the Enterprise Wealth Maximization Model 1 Peoples Department Stores Inc. (trustee of) v. Wise, [1998] QJ. No. 3571 (Q.S.C. (Bankruptcy and Insolvency Division)) (Greenberg J.). Canbook Distribution Corporation v. Borins (1999), 45 O.R. (3d) 565 (Ont. S.C.J) at para. 16; Sidaplex-Plastic Suppliers Inc. v. Elta Group (1998), 40 O.R. (3d) 53 (Ont. C.A.). See also J. Ziegel, 'Creditors as corporate stakeholders: The Quiet Revolution - an Anglo-Canadian Perspective' (1993) 43 U.T.L.J. 511. 2 Peoples Department Stores, supra, note 1, at paras. 191-6. 3 See for example, Canbook Distribution Corporation, supra, note 1, at para. 16. 4 Peoples Department Stores Inc. (trustee of) v. Wise, [2003] QJ. No. 505 (Cour d'appel du Quebec). 5 Thomas A. Smith, The Efficient Norm for Corporate Law: A Neotraditional Interpretation of Fiduciary Duty' (1999) 98 Mich. L.R. 214; Gregory S. Crespi, 'Rethinking Corporate Fiduciary Duties: The Inefficiency of the Shareholder Primacy Norm' (2002) 55 S.M.U.L.R. 141. 6 Rob Yalden, 'Competing Theories of the Firm and Their Role in Canadian Business Law,' paper presented to the Queen's Business Law Symposium, November 2002. 7 For a discussion of this issue, see J. Sarra, Taking the Corporate Ship Past the Plimsoll Line: Director and Officer Liability when the Corporation Founders' (2001) 10 International Insolvency Review 229. 8 See for example: Winkworth v. Edward Baron Development Co. Ltd., [1987] 1 All E.R. 114; Walker v. Wimborne (1976), 50 A.L.J.R. 446 (Aust. H.C.) and chapter 9 on the fiduciary duty of corporate directors in the United States. See also Andrew Keay, The Director's Duty to Take into Account the Interests of Company Creditors: When is it Triggered?' (2001) 25 Melbourne University Law Review 315. 9 See for example, ss. 245, 248, Ontario Business Corporations Act, R.S.O. 1990, c. B16. Adeeco Canada Inc. v. J. Ward Broome Ltd., [2001] OJ. No. 454 (Ont. S.C.J. (Commercial List)), Swinton, J. 10 Re Sammi Atlas Inc. (1998), 49 C.B.R. (3d) 165 (Ont. Ct. (Gen. Div.) Commercial List). 11 Derrick Tay, The Impact of Potential Environmental Law Liability on Creditors' Rights' (Toronto: Canadian Bar Association Conference, 1991) at 5-8. 12 Ontario Brownfields Statute Law Amendment Act, 2001, S.O. 2001, c. 17, Royal Assent 2 Nov. 2001, amending ss. 168.18 and 168.19 of the Ontario

Notes to pages 277-88 335

13

14 15

16 17 18 19

20 21 22

23 24

25 26 27 28

Environmental Protection Act. The Brownfields Act makes similar amendments to the Ontario Water Resources Act, S.O. 1992, as amended, and to the Ontario Pesticides Act, S.O. 1993, c. 27, as amended. It includes directors, officers, and agents of secured creditors. G. Marantz, 'Facilitating Arrangements - A Dynamic Process/ in Corporate Restructurings and Insolvencies: Issues and Perspectives (Scarborough: Carswell, 1995) at 507. S. 14.06(7), BIA. Ibid., amending ss. 19,148.1,168.20 of the Ontario Environmental Protection Act, with similar amendments to s. 89.11 of the Ontario Water Resources Act and s. 31.5 of the Ontario Pesticides Act. S. 136(1), BIA; and in the case of travelling salespersons, expenses up to $1,000. R.H. Chartrand, 'Labour and Insolvency in the 1990's' (1995) 24 C.B.L.J. 193 at 197. Ibid, at 228. An example of a joint hearing was Livent in Ontario, and in Solv-x. in Alberta. Joint hearings were provided for under the Loewen protocol. The Loewen Group, Initial Order under the CCAA, 1 June 1999 (Ont. S.C.J. Commercial List), Court File No. 99-CL3304. Re Babcock & Wilcox, [2000] O.J. No. 786 (Ont. S.C.J.). Roberts v. Picture Butte Municipal Hospital, [1998] AJ. No. 817 (Alta. Q.B.). S. 18.6 (5), (6), CCAA. For a discussion of the conflicts of laws issues, see Jacob Ziegel, 'Ships at Sea: International Insolvencies and Divided Courts' (1998) 29 C.B.L.J. 417. Re Singer Sewing Machine Co. of Canada Ltd., [2000] A.J. No. 212. Re Babcock & Wilcox Canada Ltd., supra, note 17. See also Re Grace Canada Inc. (4 Apr. 2001) (Ont. S.C.J.) Court File No. 01 CL 4081; Re Matlock Inc. (19 Apr. 2001) (Ont. S.C.J.). Jacob Ziegel, 'Corporate Groups and Canada-U.S. Cross-Border Insolvencies: Contrasting Judicial Visions' (2001) 35 Can. Bus. Law Journal 459. Bruce Leonard, 'Non-Debtor Protection in an International Case' (2000) 19 American Bankruptcy Institute Journal 28. Holt Cargo Systems Inc. v. ABC Containerline N.V., [2001] S.C.J. No. 90 at paras. 80-7. Re Singer Sewing Machine of Canada Ltd. (2000), 18 C.B.R. (4th) 127; Re Babcock & Wilcox Canada Ltd., supra, note 17; Re Canadian Imperial Bank of Commerce v. ECE Group Ltd., [2001] O.J. No. 535 (S.C.J.); Roberts v. Picture Butte Municipal Hospital, supra, note 18. For a thoughtful discussion of these issues, see Ziegel, 'Corporate Groups.'

336 Notes to pages 288-93 29 Menegon v. Philip Services Corp., [1999] OJ. No. 4080 (Ont. S.C.J.). 30 Ibid, at para. 48. 31 Guide to Enactment of the UNCITRAL Model Law on Cross-Border Insolvency 1997, XXVIII UNCITRAL Y.B, UN, Doc, A/C.N. 9/442, republished in (1999) 6 Tul. J. Int'l & Comp. Law 415. For a discussion see Ian Fletcher, Insolvency in Private International Law (Oxford: Clarendon Press, 1999); A. Berends, 'The UNCITRAL Model Law on Cross-Border Insolvency: A Comprehensive Overview' (1998), 6 Tul. J. Int'l & Comp. Law 309. 32 Similar debates in terms of the UNCITRAL Model Law, the EU Convention and other cross-border protocols are taking place in other jurisdictions. See for example, K. Dawson, 'Assistance under section 426 of the Insolvency Act' (1999) International Insolvency Review 109; Ian Fletcher 'International Insolvency: The Way Ahead' (1993) 2 International Insolvency Review 7; M. Gilreath, 'Overview and Analysis of the U.N. Model Law on Insolvency would Affect United States Corporations Doing Business Abroad' (2000) 16 Bank. Dev. J. 399.

33 Re Babcock & Wilcox Canada Ltd., supra, note 17. 34 Ss. 216(1) and (2), BIA; ss. 22(1) and (2), CCAA. 35 Ronald B. Davis, The Bonding Effects of Directors' Statutory Wage Liability: An Interactive Corporate Governance Explanation' (2002, Law & Policy, New York). 36 The Insolvency Institute of Canada and Canadian Association of Insolvency and Restructuring Professionals Joint Task Force Report in Business Insolvency Law Reform (2002), on file with the Corporate Law Policy Directorate, Industry Canada, at 21. 37 Ibid, at 9.

Index

Absolute Priority Rule (APR) 70, 235-6, 251-2 Adler, Barry 35 Agency costs 41 Alberta Business Corporations Act 224-5 Algoma Steel Corporation 3, 92, 93, 116,128-9,143,147,157-81, 273, 274, 275, 277, 282-3 Amicus curiae 97-8 Anvil Range Mining Corporation 4, 85,142,181-95, 277, 280 Armbro Enterprises 133 Babcock and Wilcox (Re) 287 Baird, Douglas 37-41 Bankruptcy and Insolvency Act 12-24; BIA proposals 19-24,120 Blair, Mr Justice 113,119-20,180, 187-9,195 Builders Lien Act 127 Canada Business Corporations Act 18, 169 Canada Pension Plan 23,177

Canadian Airlines 93,132,137-8, 146, 217-28, 273, 275, 280, 282-3 Canadian Association of Insolvency and Restructuring Professionals (CAIRP) 291-2 Canadian Red Cross 4, 80, 94,114, 124,142,196-216, 275, 278, 282-3 Chef Ready Foods 121 Chief Restructuring Officers 146-8, 176 Community stakeholders (see Stakeholders) Companies' Creditors Arrangement Act (CCAA) 12-17, 24-9,113-56,15780,181-228; class definition 29, 132-4, 206-8, 221-3; Debtor-inPossession (DIP) financing 29, 125-32, 291-2; initial stay order 21, 22, 25, 28,118,120-5; plans 24-8, 84,108-9, 205-11, 219, 221; plan sanctioning hearing 29, 111, 13440, 209-11, 224-6 Conceptual framework 56-112 Consumers packaging 4,147 Contingent claims (see Tort claimants)

338 Index Corporate governance 33, 34, 40, 41, 100-6,161-3,169-73 Court-appointed officers (see also Monitors, Receivers, and Chief Restructuring Officers) 143-6 Cram-down (see United States Bankruptcy Code} Creditors 58, 66, 99,101-2,106-10, 132-4, 219-23, 284-5; secured creditors 20, 22-5, 27-9, 32, 43, 50, 54, 58-60, 66-7, 81-9, 94,132-4, 137,139,166-7,169,170, 219-23, 284-5; unsecured creditors 14, 25, 28, 29, 32, 54, 60-1, 66-7, 81-9, 94, 132-4,168,170, 206-8, 219-23, 284-5 Crespi, Gregory 46, 47, 272 Cross-border insolvency 137, 285-9 Dallas, Lynne 33 Davis, Ronald 290 Debt collection theory 37-41, 57, 689, 100, 269-70 Debtor-in-Possession (DIP) financing 29,125-32, 291-2 Deferred liquidation (see Liquidation) Directors and officers (see also Corporate governance) 53, 64-5, 101-6, 263, 289-91 Distressed debt 83,155, 241-2 Dome Petroleum 18 Dunphy, Sean 225 Dylex 94,131 Edwards, Stanley 15 Employees 13,15,19, 48, 53, 58, 645, 69-89,112,118,147-8,157-80, 200, 227, 247-51, 255-6, 279 Employment Insurance Act 23

Enterprise value maximization theory 46-50, 57,100-6, 240-3, 267, 269-73, 289-95 Environmental liability 69,100,1924, 275-6, 291 EU bankruptcy regulation 256, 268, 285 Farley, Mr Justice 119,140, 147,157, 160,165-6 Fiduciary obligation 46-7, 57, 89, 101-6, 252-3, 271-3 First Nations 63,185,192-4 Forsyth, Mr Justice 119,136 Fracmaster 134,191 France's insolvency system 42, 22931, 237-43, 250-1, 254-5, 267-8; redressement 31, 237-43, 250-1, 254-5; reglement amiable 238-9, 250-1 Germany's insolvency system 37, 60, 229-31, 255-61 Girth, Marjorie 44, 45 Gross, Karen 10, 42-6, 97,117, 241, 244 Historical origins of Canadian insolvency regime 10-17 Holt Cargo Systems 288 Hongkong Bank of Canada 25 Houlden, The Honourable Lloyd 149, 203 Human capital investments (see Workers) Hunters Trailer 122,129-30 Hydrogenal Inc. 26 Income Tax Act 18, 23, 62, 168

Index 339 Insolvency Institute of Canada (The) 291-2 Institutional investors 62-3, 88-9, 150-6 Jackson, Thomas 37-41, 257 Judicial oversight 28-9, 31, 68, 11056,160-1,226-8 Kahn, Faith 33 Keay, Andrew 49,115, 265 Laidlaw (Re) 146 Legislative review process 6,131-2, 156, 279-95 LeSage, Chief Justice 157,166 Liquidation 31, 58, 63-4,120, 221, 293; deferred liquidation 42,110, 120; premature liquidation 11, 53, 106,120, 263 Loewen 80, 88,142,147-8 Marantz, Gordon 117 Market theory 34-6 Miners Lien Act 61,127,183,193 Monitor 26, 144-6, 198-206 Morawetz, Geoffrey 145 Myers, Fred 119 Oakwood Petroleum 146 O'Connor, Marleen 33 Olympia & York 113,135 Oppression 103, 224-6, 273 Paperny, Madame Justice 217, 226 Participation rights 81-9,173-80, 197,199-202, 211-16 Pay Equity Act 204-5

Peoples Department Stores v. Wise 271-3 Phillips Services 288 Plan of arrangement (see under CCAA) Plan sanctioning hearing (see under CCAA) Policy instruments 53-5 Policy objectives 51-2 Posner and Kordana 81 Post-petition trade credit (PPTC) 130-2 Private workouts 17, 66 PSINet 124,136-7 Quintette Coal 28,114 Rasmussen, Robert 35-6 Receiver 20, 21, 87,150-6,192-4 Redressements (see France) Rehabilitation theory 42-6, 57, 270 Repairer and Storage Liens Act 61 Repap British Columbia Inc. (Re) 139 Roberts v. Picture Butte 286-7 Rotsztain, Michael 115 Royal Oak Mines 63, 90-1,122-3,126, 142, 282 Schiller, Christof 257 Secured creditors (see Creditors) Securities Act (Ontario) 123-4 Sellers, Edward 119,147-8 Singer Sewing Machine (Re) 287 Skeel, David 233, 235 Smith, Thomas, 46, 272 Smoky River Coal (Re) 131 Social stakeholders (see Stakeholders) Stakeholders (including community, social stakeholders, public interest

340 Index stakeholders) 11, 43-6, 50, 57, 58, 65, 89-100,107-8,112,114-15, 163-4,173-80,181-95,197, 211-16, 244-5, 277-84 Starcom (Re) 191 Stay order 21, 22, 25, 28,118,120-5 Skydome Corporation 144-5 T. Eaton Co. 60, 87, 93,145, 282 Theoretical approaches 30-53 Tort claimants 44, 63, 69, 94-7,112, 114,196-216, 245-7,277-8 Trade suppliers (see Unsecured creditors and Post-petition trade credit) Trustee 21-4, 87 Tysoe, Mr Justice 28 United Keno Hill Mines 123-4 United Kingdom insolvency system 49, 229-31, 255-7, 261-8, 273

United States Bankruptcy Code 13,16, 37, 42, 43, 45, 68, 70,105,133,142, 208, 212-13, 229-37, 241-2, 244-54, 260, 267, 273, 285-7; absolute priority rule 70, 235-6, 251-2; cram-down 133, 232, 236; DIP estate 68, 232; executory contracts 247-51, 267, 292-3 United Used Auto 126,128 Unsecured creditors (see Creditors) Veach, Julie 244 Warren, Elizabeth 47-50 White, Michelle 246-7 Winding Up Ad 12 Woodwards Ltd. (Re) 133 Workers 13,15,19,48, 53, 58, 64-5, 69-89,112,118,147-8,157-80, 200, 227, 247-51, 255-6, 279