Not So Fast – Audit Restricts Appointment of Monitor

February 22, 2024

Authors: William Skelly, Jess Reid, MLT Aikins

A recent decision of the Ontario Superior Court (“Court”) provided insights into how the Courts may interpret Section 11.7 of the Companies’ Creditors Arrangement Act (“CCAA”) in the future where a company is seeking to appoint a firm as monitor in a CCAA proceeding where the firm (or a firm related to it) had acted as auditor to that company within the preceding 24 months.

Background

On December 22, 2023, Trees Corporation, Ontario Cannabis Holdings Corp., Miraculo Inc., 2707461 Ontario Ltd., OCH Ontario Consulting Corp., and 11819496 Canada Inc. (collectively, the “Debtors”) sought protection from their creditors by initiating proceedings under the CCAA (the “CCAA Proceeding”). In the CCAA initial order (the “Initial Order”), Ernst & Young Inc. (“EY Inc.”) was appointed as the monitor over the Debtors.

At the initial application, EY Inc. disclosed to the Court that an affiliate entity, Ernst & Young LLP (“EY LLP”), had acted as an auditor of Trees until it had resigned on May 10, 2022, less than 24 months from the date of the Initial Order. Notwithstanding that no other party raised an issue with the appointment of EY Inc. as monitor, the Court challenged EY Inc.’s ability to act as monitor of the Debtors in light of section 11.7 of the CCAA and sought arguments from EY Inc. at the comeback hearing.

The Court’s decision

The Court was faced with the question of whether it should exercise its discretion to permit EY Inc. to continue to act as the monitor of the Debtors pursuant to section 11.7 of the CCAA notwithstanding that EY Inc. was restricted from doing so as a result of EY LLP’s auditing engagement terminating less than 24 months from the date of the Initial Order. The Court was not concerned with EY Inc.’s integrity or professionalism with respect to their appointment, but rather the interpretation of the restriction in subsection 11.7(2).

Justice Morawetz began his analysis by examining the case law advanced by EY Inc. and the language from the predecessor version of subsection 11.7(2) of the CCAA. The case law relied upon by EY Inc. was distinguished on the facts or because it provided limited or no analysis with respect to the current version of subsection 11.7(2) of the CCAA.

The predecessor version of subsection 11.7(2) stated that, “unless otherwise directed by the Court,” the auditor of a company may be appointed as the monitor of that company. The current version of subsection 11.7(2) is more restrictive and provides that, “except with permission from the Court,” no trustee may be appointed as monitor if that trustee, or a trustee related to that trustee, has acted as the auditor of the company during the preceding two years.

Justice Morawetz stated that, given the clear wording in the CCAA,  only extenuating circumstances would justify the appointment or continuation of the appointment of EY Inc. to act as monitor where they are captured by the restriction in subsection 11.7(2).

While EY Inc. asked the Court to find extenuating circumstances in this CCAA Proceeding, the Court ultimately found the arguments made by EY Inc. to be self-serving and the Court did not exercise its discretion to allow EY Inc. to continue to act as monitor. Justice Morawetz’s responses to EY Inc.’s arguments were as follows:

  • While EY Inc. was familiar with the Debtors’ assets and business, EY Inc. was aware of or ought to have known of the restrictions in subsection 11.7(2) prior to spending the time and money preparing for the CCAA proceeding as another insolvency professional could have become equally familiar with the Debtors’ assets and business.

  • EY Inc. did not have any unique knowledge in this industry. EY Inc. had extensive and in-depth knowledge of the Debtors’ cannabis business, the cannabis sector and the cannabis retail sector, but other insolvency firms have also developed competency in the cannabis sector.

  • If there is an increase to professional costs in the CCAA proceeding due another party being appointed as monitor, it will be because EY Inc. chose to proceed with its appointment, notwithstanding the language of the CCAA. The Court should not allow EY Inc. to create a factual matrix and then request the Court to exercise its discretion to override the restrictions.

  • The Court may be willing to appoint an ineligible trustee as monitor in the interim if there is a need to proceed expeditiously but that does not mean the appointment of the trustee will not be reviewed at a later date.

  • Notwithstanding that EY Inc. was not aware of any real or perceived apprehension of bias or impartiality, it is necessary to avoid any appearance of conflict or bias. This is especially the case where there may be reviewable transactions where such transactions occurred while the former related auditor was engaged.

The Court emphasized that the baseline requirement for a monitor is that it be independent and free from real or perceived conflict. The appointment of a trustee as monitor who is otherwise subject to the statutory restriction is an exception to the rule and their appointment will require extenuating or unique circumstances in order for the Court to exercise its discretion for such an appointment. The Court also indicated that it will be taking extreme caution in assessing the factual matrix surrounding the appointment of an monitor including whether there were any transactions entered into during the subsection 11.7(2) restriction period and whether the factors militating in favour of the appointment were created by the parties.

This decision by Justice Morawetz for the Ontario Superior Court is instructive as it signals that trustees should be cautious before seeking to be appointed as monitor over a company where the trustee’s eligibility for appointment is restricted as a result of subsection 11.7(2) of the CCAA.

Vancouver lawyers William E. J. Skelly and Jess R. Reid were pleased to act as counsel to 606093 Saskatchewan Ltd., Echo Capital Growth Corporation, Minerva Investments Ltd., PMH Investco Ltd. and 1181798 B.C. Ltd. in this case.

MLT Aikins insolvency and restructuring group comprises of 24 lawyers practicing in six offices across all four western Canadian provinces. Our insolvency and restructuring experience helps our clients preserve value, capture business opportunities and resolve disputes across various sectors of the western Canadian economy.

Note: This article is of a general nature only and is not exhaustive of all possible legal rights or remedies. In addition, laws may change over time and should be interpreted only in the context of particular circumstances such that these materials are not intended to be relied upon or taken as legal advice or opinion. Readers should consult a legal professional for specific advice in any particular situation.