Will a court approve a reverse vesting order if it is opposed by a creditor who would otherwise have veto power over a plan?
Quest obtained protection under the CCAA in January 2020. The principal purpose of the CCAA proceedings was to identify a partner/investor to purchase Quest’s real property and/or identify an academic partner/investor that would permit Quest to continue as a post-secondary institution. Quest was the limited partner in a limited partnership agreement with Southern Star Developments Limited (“Southern Star”), who was the General Partner. Quest owned lands on which it built student residences and leased them to Southern Star. Once the residences were built, Southern Star, as landlord, and Quest, as tenant, entered into subleases.
On October 23, Quest issued Notices of Disclaimer to Southern Star with respect to the four subleases covering the residence buildings. On October 28, Quest entered into an agreement (subject to court approval) for the sale of its assets to Primacorp Ventures Inc. The transaction was conditional on (1) the disclaimer of the subleases with Southern Star; and (2) approval of a Plan. Following the disclaimer of the subleases, Southern Star brought an application to prohibit the disclaimers, arguing that, among other things, it stood to suffer significant financial hardship, and the disclaimers were designed to extract concessions from Southern Star in future negotiations with the company or Primacorp.
PwC as Monitor noted in its Fifth Report that the disclaimer of the subleases, if approved by the Court, would likely give rise to an unsecured claim that would give Southern Star an effective veto on the approval of the Plan. As a result, Quest negotiated an amendment to the Primacorp transaction which removed the condition precedent requiring that a Plan be approved and instead made the transaction conditional on the granting of a Reverse Vesting Order (“RVO”). The draft RVO proposed to transfer Quest’s obligations under the Southern Star subleases to a wholly owned subsidiary (referred to as Guardian) formed for this purpose. Because Guardian will not have the financial resources to meet those obligations, it is expected to default on the subleases in January 2021.
The Primacorp transaction also provided for:
- Sufficient funds to pay Quest’s secured creditors’ claims, including claims secured by the CCAA charges;
- Funding for a plan of arrangement in Guardian’s CCAA proceedings to be voted on by Quest’s unsecured creditors;
- Funds for the insolvency proceedings; and
- A working capital facility, and marketing and recruiting support to permit Quest to become self-sustaining as a post-secondary institution.
Justice Fitzpatrick of the British Columbia Supreme Court granted the RVO on November 16 and released her reasons on December 2. Justice Fitzpatrick relied on a number of recent authorities from Quebec and Ontario and found that there is no provision in the CCAA that prohibits an RVO structure. Section 36 of the CCAA allows the court a broad discretion to consider and, if appropriate, grant relief that represents an innovative solution to any challenges in a proceeding. In doing so, the court must keep in mind three “baseline considerations”, which the applicant bears the burden of demonstrating: (1) that the order sought is appropriate in the circumstances, and (2) that the applicant has been acting in good faith and (3) with due diligence. Appropriateness “is assessed by inquiring whether the order sought advances the policy objectives underlying the CCAA”. The requirement that parties must act in good faith in insolvency proceedings has been made express in section 18.6 of the CCAA.
Justice Fitzpatrick found that Quest was not seeking to bar Southern Star from voting on the Plan. It sought approval of a structure that would result in Quest’s subsidiary submitting its own plan to the unsecured creditors, which would include Southern Star and Dana, at which time they would be generally free to vote their “self-interest” subject to any relevant constraint. Primacorp presumably made the best offer that it was prepared to make in the circumstances. Without the RVO structure, the Primacorp transaction was in jeopardy. The only other likely path forward for Quest was receivership, liquidation and bankruptcy.
The Primacorp transaction would ensure that Quest continued as a going concern, by continuing operations as a post-secondary institution. This would result in continuing benefits to the broad stakeholder group (i.e., faculty, staff, students, secured and unsecured creditors, suppliers, landlords and the community generally). Justice Fitzpatrick acknowledged the negative consequences that would arise for Southern Star under the Primacorp transaction. However, Southern Star could mitigate its financial hardship by entering into an agreement with Primacorp for use of some or all of the residences. By contrast, Quest’s other stakeholders had no ability to mitigate their potential losses in the event that the Primacorp transaction fell through.
Southern Star sought leave to appeal the RVO. Justice Harris of the British Columbia Court of Appeal dismissed the application for leave to appeal on December 7 and released his reasons on December 17. Justice Harris accepted, for the purpose of the leave application, that the nature of the order sought to be appealed (the RVO) is unusual in CCAA proceedings and is of significance to the practice and to the parties. However, Justice Harris was not persuaded that the appeal was meritorious, considering the prospects that an appellate court would interfere with Justice Fitzpatrick’s exercise of her discretion to be remote. This was especially so in light of Justice Fitzpatrick’s assessment, grounded in months of experience of managing the proceedings, that the consequences of not approving the transaction would be catastrophic. The grounds of appeal advanced by Southern Star raised essentially the same arguments which were dismissed by Justice Fitzpatrick.
Justice Harris also found that Justice Fitzpatrick acknowledged the negative impact to Southern Star arising from the relief she granted, though she questioned the extent of that damage; she gave some credence to the suggestion, as Quest argues in this application, that Southern Star’s arguments were made strategically with a view to gaining leverage, while significant other interests hung in the balance: Ultimately, however, she accepted that Southern Star would suffer harm but balanced that impact with the “myriad interests held by other stakeholders” and chose the best option for everyone involved, including Southern Star. Justice Harris concluded that the RVO reflected precisely the type of intricate, fact‑specific, real‑time decision making that inheres in judges supervising CCAA proceedings, and which forms the basis for the considerable deference their decisions are afforded on review.
Counsel: John R. Sandrelli and Valerie Cross of Dentons for Quest; Vicki Tickle of McMillan for the Monitor; Peter Rubin and Greg Umbach of Blake, Cassels & Graydon for Primacorp Ventures Inc.; Peter J. Reardon and Kayla Strong of Nathanson, Schachter & Thompson for Southern Star Developments Ltd.; and Dahlia V. Bateman, General Counsel for Dana Hospitality LP
Judges: Fitzpatrick J.; Harris J.