Should senior secured lenders be placed in a separate class from subordinate secured lenders?
Wiivv filed a Proposal to its creditors, the purpose of which was to restructure and reorganize Wiivv in a manner that permits it to continue operations as a going concern in its business. The Proposal contemplated two classes of creditors: the Lienholders and the Unsecured Creditors. Under the Proposal, the Unsecured Creditors shared in a $100,000.00 Proposal Fund. The Lienholders’ secured debt would be converted into newly-issued common shares in Wiivv, with one common share being issued for each dollar of proven claim. The Proposal Trustee recommended that both classes of creditors support the Proposal.
The Lienholder class included all claims of all secured creditors holding a security interest in Wiivv’s property, including the Senior Indebtedness class and Subordinate Indebtedness class, which were created pursuant to an amended and restated pari passu priority agreement. The “Senior Indebtedness” class totalled $3,000,000, while the “Subordinate Indebtedness” class totalled about $4,300,000.
Four of the Senior Indebtedness secured creditors of Wiivv sought a declaration that the “Senior Indebtedness” constitutes a separate class of secured claims in the Proposal and that the Proposal is not binding on secured creditors in respect of their claims in the Senior Indebtedness class. They argued that the Lienholders class lumps creditors whose claims give them two distinct commonalities of interest into a single class, and forcing them into the same class was a confiscation of their rights as Senior Indebtedness holders.
In its opposition, Wiivv submitted that the Lienholders were appropriately classified as one class in the Proposal in accordance with the requirements of the Bankruptcy and Insolvency Act. The Proposal Trustee disputed that a different classification was required at law and adopted the position expressed by Wiivv.
In a proposal under the Bankruptcy and Insolvency Act, secured claims may be included in the same class based on commonality of interest, as determined by a list of criteria, and the Court may determine the appropriate classes of secured claims in accordance with that list of criteria (s. 50(1.4) of the BIA):
1. the nature of the debts giving rise to the claims;
2. the nature and rank of the security in respect of the claims;
3. the remedies available to the creditors in the absence of the proposal, and the extent to which the creditors would recover their claims by exercising those remedies; and
4. the treatment of the claims under the proposal, and the extent to which the claims would be paid under the proposal.
The commonality of interests is to be viewed purposively, bearing in mind the object of facilitating reorganizations if at all possible. Courts should be careful to resist classification approaches that could jeopardize potentially viable plans and also be wary of creating a class that may result in either the “confiscation of legal rights” or a “tyranny of the minority”. Absent bad faith, the motivations of the creditors to approve or disapprove are irrelevant.
Regarding the nature of the debts, there was no dispute that the applicants and other creditors holding Senior Indebtedness had valid, secured debt, or that Wiivv and all of its secured creditors agreed to create two classes of secured debt, granting priority to the Senior Indebtedness.
Regarding the nature and rank of the security, the applicants argued that the priority of a creditor’s security interest over those of another creditor in the same collateral was evidence of the lack of a commonality of interest between the creditors. However, the Court held that the debt and security were not fundamentally different. The issue was priority of debt. While priority can be a significant factor in the proper classification of secured creditors, it is not the only factor. The applicants sought a declaration that creditors who held an identical security interest over identical collateral with virtually identical supporting legal documents which provided for identical remedies on enforcement should be placed into separate creditor classes. The Court concluded that the applicants’ proposed reclassification was the type of excessive fragmentation that should be avoided.
In the absence of the Proposal, the applicants and other holders of Senior Indebtedness would be entitled to enforce their security, with the proceeds of such enforcement being applied first to the Senior Indebtedness, pari passu, in accordance with the priority agreement. They argued that their likely recovery in the absence of the Proposal would be significantly superior to the likely recovery of the creditors holding Subordinated Indebtedness. The Court disagreed and found that both Senior Indebtedness and Subordinate Indebtedness would have a commonality in the extent of their recovery from other remedies if the Proposal was not accepted.
Finally, regarding the fourth factor, the Court noted that the Proposal treated all secured creditors equally. The Proposal did not recognize the priority of the Senior Indebtedness, for example by providing for an increased ratio of shares to debt for the holders of Senior Indebtedness as the applicants sought.
Counsel: Colin Brousson of DLA Piper for A&M as Proposal Trustee; Lance Williams and Forrest Finn of Cassels for Wiivv; Vicki Tickle of McMillan for FAMB I, LLC; Scott Boucher of Norton Rose Fulbright for Evonik Venture Capital GmbH; Gregory J. Gehlen and Lee J. Marriner of Gehlen Dabbs for Rajan Holdings Inc., New Avenue Capital Inc., KSSS Management Corp. and Steven Lukas Law Corporation
Judge: Madam Justice Watchuk