DIP lender vs post-filing creditors: Quebec Court of Appeal confirms the prior rank of a DIP lender challenged by unpaid post-filing creditors

by Ari Sorek of Dentons 

In a unanimous judgement rendered on August 27, 2019, in the matter of Gestion Éric Savard Inc. (Re), the Quebec Court of Appeal confirms the super-priority rank of an interim lender in the face of a challenge by unpaid post-filing creditors.

The Debtors, including Gestion Eric Savard Inc., which operated a group of optometry clinics in Quebec and Ontario, obtained relief under the Companies’ Creditors Arrangement Act in May 2017, including a stay of proceedings and an authorization to borrow approximately $4.5 million from Fiera FP s.e.c. (“Fiera”) as interim (“DIP”) financing. To secure the interim financing, the CCAA Court granted a priority security interest to Fiera, charging all of the Debtors’ assets, pursuant to section 11.2 of the CCAA. The order granting the interim financing charge read as follows:

DECLARESthat all of the Applicants’ assets are hereby charged and secured up to a totalamount of $5,750,000.00 (such charge and security constitutes the(“Temporary Lender’s Charge”) in favour of the Temporary Lender, assecurity for all of the Applicants’ obligations to the Temporary Lender withrespect to all amounts owed (including principal, interest, and TemporaryLender’s Expenses) arising out of or related to the Temporary Financing Termsand Conditions and the Temporary Financing Documents, such that the TemporaryLender’s Chargee shall take precedence over the mortgage rights of the othersecured creditors of the Applicants for the purposes of section 11.2 of theCCAA, subject, however, to the following rights: […].

In August 2017, further to theconclusion of certain transactions under the auspices of a Court-approved salesprocess, the Monitor presented a motion for authorization to sell certainassets of the Debtors and for the issuance of a vesting order. At the hearing,certain post-filing creditors, including certain landlords (for unpaid rent)and a bank (as creditor under a term loan) asserted rights over the proceedsderived from the realization of the Debtors’ assets, and requested that theMonitor be ordered to first distribute said proceeds to the post-filingcreditors, in priority to the DIP lender and any other secured creditor. Ratherthan subsuming the issuance of the vesting order to the outcome of a potentiallyprotracted debate over the eventual distribution of sale proceeds, and to avoidpotentially jeopardizing the transaction in question, the Court agreed to issuethe vesting order but postponed the debate on the distribution mechanisms to alater date. Pending the outcome of a future order on the distribution ofproceeds, the Monitor was to reserve an amount of $750,000 in trust (the “Amount in trust”), to ensure the availabilityof funds at the time of final disposition.

In November 2017, themonitor sought directions from the Court regarding the distribution of theAmount in trust. The Superior Court, based mainly on its interpretation of thepurpose and intent of the August 2017 order (rendered by a different judge),concluded that the Amount in trust must be distributed as follows:

• First, post-filling debts, defined as any debt incurred after May 18, 2017;

• Second, secured debts of creditors holding a security interest in the assets sold, as per their rank under the law and under court orders;

• Third, where applicable, the priority claims referred to in section 136 of the Bankruptcy and Insolvency Act; and

• Fourth, where applicable, other debts.

Fiera appealed said judgement onthe grounds that, in establishing this collocation order, the judge failed toconsider the super priority recognized in the initial order and in the CCAA.The post-filing creditors contended that, owing to the importance ofsafeguarding the rights of post-filing creditors, and to the extent that the Amountin trust was reserved by the first judge to ensure availability of funds forpost-filing suppliers, these amounts ought to be distributed to them first. The Court of Appeal granted the appeal and confirmed that there is noinherent security for post-filing creditors—they are required to petition theCourt in order to obtain such security. The Court of Appeal noted thatpost-filing creditors may avail themselves of certain recourses to safeguardtheir interests in respect of unpaid goods or services, including, for example,seeking an order pursuant to section 11.4 CCAA declaring them to be criticalsuppliers, with an order establishing payment terms or a critical suppliers’charge. In the absence of such an order granting priority or other protectionto post-filing suppliers, the Court of Appeal confirmed the super priority ofthe DIP lender and ordered that the distribution be made in accordance with theprovisions of the CCAA and the initial order.

Perhaps implicitly applying the “building blocks” doctrine evoked by Justice Morawetz in Re Target Canada Co., 2016 ONSC 316, the Court of Appeal reaffirmed the importance for stakeholders to assert rights or otherwise participate in proceedings in a timely and transparent fashion, lest previously established modi vivendi be disturbed to the detriment of other stakeholders, who, in navigating the CCAA process, had relied on the parameters drawn up by prior Court orders. In the case at bar, the DIP lender was asked to disburse additional tranches of financing at various subsequent steps of the CCAA proceedings, relying on the protections afforded by the interim financing charge, did not suspect that its position could be jeopardized by the latent claims of certain creditors.

The ruling is noteworthy in that itappears to be the first one in Canada wherein a court was tasked withadjudicating competing claims between post-filing creditors and the beneficiaryof a CCAA charge, both being categories of creditors which are otherwisehabitually accorded augmented protections in CCAA processes.

It is also noteworthy that theCourt of Appeal attributes the result of the impugned distribution orderrendered by the Superior Court, at least in part, to the fact that more thanone judge was tasked with managing the CCAA process, thereby compelling onejudge to interpret prior orders and preventing any given judge from having afull and complete picture of the entire process.

The ruling will surely come as welcome comfort to DIP lenders and restructuring professionals. The sacrosanct protection that is often attributed to such lenders is reaffirmed; this protection has a direct impact on the level of risk to be managed by lenders, which risk, in turn, directly affects the availability and costs of such financing.

A copy of the decision can be downloaded below.

09-9672-178-09-9673-176-27août19.pdf

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