Asserting a constructive trust with priority over a DIP lender?

In the Matter of a Plan of Compromise or Arrangement of BZAM Ltd. et al., 2024 ONSC 6735
What is the test for establishing a constructive trust in a CCAA proceeding?

Summary: A party entered into in agreement with the debtor prior to the debtor’s CCAA filing to sell the shares of its subsidiary to the debtor in exchange for equity and unsecured debt in the debtor. Well after the debtor obtained CCAA protection and a DIP loan, the party asserted a constructive trust in relation to the debtor’s assets and claimed priority over the DIP lender. The Court rejected the party’s claims, finding that they were a collateral attack on the ARIO and the DIP agreement, which the party had not challenged at the appropriate time. In any event, even if the party’s claim was successful, it could not rank in priority to the DIP lender’s charge because it was an “equity claim”, which ranks behind the claims of all creditors, not just creditors with court-ordered priority charges.

Cortland sought a declaration that any potential entitlement of Final Bell Holdings to a constructive trust in relation to assets of BZAM or the proceeds of the sale thereof was subordinate to the security interest of Cortland over those assets and its corresponding charge, and to Cortland’s entitlement to a distribution of such proceeds. The relief sought by Cortland was supported by BZAM and opposed by Final Bell.

Final Bell, its Canadian subsidiary Final Bell Canada Inc. (“FBC”), and BZAM entered into a Share Exchange Agreement on December 5, 2023, pursuant to which Final Bell sold FBC to BZAM, in exchange for equity and unsecured debt in BZAM. At the time, Cortland was already the existing lender to BZAM through a credit agreement with BZAM’s subsidiary. On January 8, 2024, three days after the Final Bell transaction closed, BZAM and Cortland entered into a further amended and restated credit agreement (“the Second ARCA”) to add Final Bell and FBC and their assets to the collateral already pledged to Cortland by BZAM.

Pursuant to the Second ARCA (and after the Share Exchange Agreement), Cortland made available to BZAM revolving advances totalling another $18 million. Cortland argued that it made the credit advances as a bona fide purchaser for value without notice of the claims of Final Bell, and that in any event, the vast majority of its pre-filing advances also predated the Share Exchange Agreement with Final Bell. Cortland’s position was that the Final Bell assets then owned by BZAM formed part of the collateral pledged in its favour. Final Bell argued that BZAM made fraudulent misrepresentations to it that it relied on in entering into the Share Exchange Agreement, and that Cortland had constructive knowledge of those fraudulent misrepresentations.

On February 28, 2024, BZAM was granted protection under the CCAA. Cortland agreed to provide a DIP credit facility in accordance with the DIP Agreement of the same date. The subsequent Amended and Restated Initial Order affirmed the approval of the DIP Agreement and Cortland’s super priority charge over all existing and after-acquired assets of BZAM (including the Final Bell assets). Further, and consistent with the terms of the Commercial List Model Order, the ARIO confirmed the priority of that super priority charge over, among other things, all trusts. In reliance on the super priority status of the DIP Lender’s Charge, Cortland thereafter made advances under the DIP Agreement.

The Court held that the declaratory relief sought by Cortland should be granted. First, the constructive trust claim advanced by Final Bell was inescapably a collateral attack on the ARIO and specifically the approval of the DIP Agreement and the super priority DIP Lender’s Charge in favour of Cortland that secured the DIP Loan. The DIP Loan represented “new funds in” to BZAM, on a Court-approved basis pursuant to the ARIO, which funds were expressly required to keep BZAM operating as a going concern for the benefit of all stakeholders, including creditors and employees. Final Bell was specifically given notice of the comeback hearing, and even attended at the hearing resulting in the ARIO. However, Final Bell did not oppose the approval of the DIP Agreement, the granting of the DIP Lender’s Charge, or the fact that post-filing collections would be used to repay the pre-filing secured indebtedness owing to Cortland. If Final Bell sought to oppose the priority afforded to Cortland through the DIP Lender’s Charge, or in particular the structure of the DIP Term Sheet, that was the time to do so.

In any event, there was no other alternative source of funding to provide the required liquidity. It would be inequitable, unjust, and contrary to the basic principles of CCAA restructurings to allow Final Bell to have elected to not oppose that relief when granted on notice, then later advance a claim for rescission, then abandon that claim for rescission in the face of the pending SISP deadlines, and then later still advance a claim for a constructive trust over those same assets and seek a corresponding priority over the DIP Lender’s Charge that had been in place for months. Such a constructive trust inescapably undermined the ARIO—a seminal order in most CCAA restructurings because it sets out the framework within which the restructuring will proceed—and the imposition of a constructive trust would inevitably reverse the priorities established and confirmed by the ARIO.

Where a lender, as a source of DIP funding, steps forward, all stakeholders are given notice of the proposed terms of the DIP financing and the opportunity to make submissions about whether those terms should be approved. There is nothing unusual or inappropriate about a court-ordered financing charge that has priority over “all other security interests, trusts, liens, charges and encumbrances, statutory or otherwise”. Where that occurs, as it did here, another stakeholder cannot bide its time while the DIP lender advances funds in reliance on its security, and the debtor continues as a going concern as a result thereof, and then come forward months later when DIP funds have been advanced to assert a priority in the form of a constructive trust that would prime the court-approved DIP charge.

Final Bell argued that it did not take any of these steps because it did not have the knowledge and, therefore, the ability to advance the constructive trust claim. The Court did not accept this argument. First, Final Bell clearly knew the nature of the misrepresentations upon which it based its entire claim. Final Bell’s basic claim had three components: that BZAM intentionally misrepresented its financial circumstances and solvency (including but not limited to the fact that it was current in its excise tax filings and remittances), that Final Bell relied on the misrepresentations, and that it would otherwise not have entered into the Share Exchange Agreement. Second, Final Bell was also seeking rescission of the Share Exchange Agreement as soon as it advanced its claim as a result of those alleged misrepresentations. Finally, Final Bell knew, as of that date on which it first advanced its claim, that it needed to prime the DIP Facility and therefore obtain a priority over the DIP Lender’s Charge in order to succeed on its claim. Yet, it took no steps to do so either at the comeback hearing or at any time thereafter. It failed to avail itself of the seven day “comeback clause” in the ARIO, bring any motion to amend the ARIO, or seeking urgent relief as the Commercial List routinely accommodates from parties in appropriate circumstances. In the face of multiple and continuing opportunities to challenge the priority of the DIP Lender’s Charge, the subsequent collateral attack on the ARIO could not succeed.

Moreover, Final Bell’s claim, even if ultimately successful, could not rank in priority to Cortland’s super priority DIP Lender’s Charge because it was an “equity claim”, which ranks behind the claims of all creditors, not just creditors with court-ordered priority charges. Equity claimants are not entitled to share in assets of an insolvent corporation until the claims of all ordinary creditors have been paid in full. Final Bell bought an equity interest in BZAM in exchange for its Canadian subsidiary. It did not supply goods or services, and it was not an employee. It was a party to an agreement pursuant to which it acquired shares. In asserting its late-breaking claim for a constructive trust, Final Bell sought to elevate what was inescapably an equity claim into a claim of not only a creditor, but a first-ranking creditor with priority over the Court-ordered super priority DIP Lender’s Charge.

It would be entirely destabilizing to grant Final Bell a priority over the DIP Lender’s Charge, and fundamentally inconsistent with the objectives of the restructurings that the CCAA was intended to facilitate. Accordingly, the Court granted Cortland’s motion.

Judge: Justice Osborne

Counsel: Alan Merskey and Colin Pendrith of Cassels for Cortland

Joseph Blinick and Michael Shakra of Bennett Jones for BZAM

Maria Konyukhova, Nick Avis and Andrew Neayem of Stikeman Elliott for FTI as monitor

Andrew Winton of Lax O’Sullivan for Final Bell