DIP charge a material prejudice to pre-existing secured creditor?

Re Valeo Pharma Inc.
Does an increased DIP charge constitute material prejudice to a pre-existing secured creditor?

Summary: In this case, the Court considered whether an increased DIP charge should be approved, or whether it constituted material prejudice to the pre-existing secured creditor, who argued that a higher DIP charge would prejudice the creditor’s ability to recover its loan upon an eventual sale or liquidation of the company’s inventory and accounts receivable (the only tangible assets of value). The Court approved the increased DIP charge, finding that various measures put in place — including undertakings that the combined amount of the DIP loan and pre-existing secured lender’s loan would not exceed the aggregate value of the company’s assets at any given time, minus $1M — provided a safety cushion and reduced the risk that the pre-existing secured creditor’s loan would not be repaid. In addition, the risk to the pre-existing secured creditor through the increased DIP charge was outweighed by the clear advantage to stakeholders in permitting the company to receive interim financing and continue its business operations while it conducts a SISP.

The Applicants (also referred to as “Valeo”) sought an initial order under the CCAA to stay proceedings, authorize interim financing, appoint a monitor, and charge the Applicants’ assets while they proposed a restructuring plan to the Court. The Court issued an initial CCAA order authorizing an interim loan by Sagard to Valeo of US$750,000 (the “DIP Loan”) and the creation of a super priority charge (“DIP Charge”) of $1.2M in favour of Sagard as the DIP lender. In doing so, the Court held that the DIP Charge in favour of Sagard did not cause prejudice to Accord, a secured creditor of Valeo, because the value of Valeo’s inventory and account receivables, on which Accord held first ranking security, was superior to the amount of the DIP Charge and Accord’s outstanding $3.2M loan.

On October 11, 2024, the parties returned to Court seeking an amended initial order and an extension of the stay of proceedings. Valeo sought an order, inter alia, authorizing it to conduct a SISP, borrow up to US$5M under the DIP Loan and increase Sagard’s DIP Charge to $8M. Accord opposed the proposed increase to the DIP Charge, arguing that a higher DIP Charge would prejudice Accord’s ability to recover its $3.2M loan upon an eventual sale or liquidation of Valeo’s inventory and accounts receivable (being the company’s only tangible assets of value).

The Court found that Valeo would maintain a higher level of inventory and accounts receivable during the SISP period than was initially anticipated. Higher levels of inventory and receivables provided greater assurance to Accord that there would be tangible assets to pay the DIP Charge and the Accord loan at the end of the SISP period. Further, the Monitor reviewed expressions of interest from potential purchasers of Valeo’s business and believed that the company’s value exceeded that of its inventory and receivables. Given the apparent interest in Valeo’s business, a liquidation scenario was unlikely and a sale of the business could generate sufficient sums to repay the DIP Charge and Accord’s secured loan.

Valeo undertook not to draw upon the DIP Loan, and Sagard undertook not to advance DIP funds, if, at any time, the combined amount of the DIP Loan and the Accord loan exceeded the aggregate value of Valeo’s cash, inventory and receivables, minus $1M. Valeo further undertook to immediately advise Accord and the Court in the event that it anticipated that the combined DIP Loan and Accord loan would exceed the above-mentioned ceiling. These undertakings provided a safety cushion to Accord. Finally, under the terms of the SISP, the Monitor undertook to allocate the purchase price of an accepted bid to Valeo’s assets according to their respective value. This allocation was expected to ensure that an eventual offer would not attribute an unfair value to Valeo’s inventory and accounts receivable over which Accord has first ranking security.

In the Court’s view, these measures reduced the risk that Accord’s secured loan would not be repaid at the end of a SISP. While the proposed measures did not eliminate all risk or leave Accord as secure as it would be if its first ranked security were not primed by the DIP Charge, they provided substantial protections. The risk of non-payment was future and hypothetical, while material prejudice is conceived as present and certain. In this case, the potential and measured risk to Accord did not rise to the threshold of material prejudice.

When considering whether to increase the DIP Loan and DIP Charge, the Court had to weigh all relevant factors. The risk to Accord through an increased DIP Charge was outweighed by the clear advantage to stakeholders in permitting Valeo to receive interim financing and continue its business operations while it conducts a supervised sales process. During the sales process, and possibly thereafter, Valeo’s jobs would be maintained, its suppliers would be paid, and Valeo’s pharmaceutical products would continue to be found on pharmacy shelves. While the SISP offered a potentially greater recovery for all creditors, a liquidation would only benefit Accord.

Accordingly, the Court granted the application.

Judge: The Honourable David Collier, J.S.C.

Counsel: Éric Vallières, Emile Catimel-Marchand and Tushara Weerasooriya of McMillan for Valeo Pharma; Alain Tardif and Marc-Étienne Boucher of McCarthy Tétrault for EY as monitor; William McNamara and Tony Demarinis of Torys for Sagard Healthcare Partners; Gerald Kandestin, Jeremy Cuttler, Claudia Giroux of Kugler Kandestin for Accord Financial