In a decision released on April 20, 2017, Regional Senior Justice Morawetz of the Ontario Superior Court of Justice dismissed the Payless Group’s application for an order under section 49 of the Companies’ Creditors Arrangement Act (Canada) (”CCAA”) (a) recognizing in Canada an interim debtor-in-possession (“DIP”) financing order made by the US Bankruptcy Court (Eastern District of Missouri) (the “Interim DIP Order”) and (b) granting a DIP charge on the property of three Canadian Payless entities (“Payless Canada Group”), wholly-owned by US Payless entities, ranking in priority to all unsecured claims, but subordinate to certain court-ordered charges.
The basis for the Court’s decision was the failure of the proposed DIP order to include protection for payments owing to Canadian landlords. In contrast, the proposed order did include protection for other Canadian creditor groups.
In CCAA recognition cases involving DIP facilities or other relief, the foreign debtors, through their foreign representatives, often make “in terrorem” submissions to the Court, arguing that unless the Court grants all the relief sought, disaster will result. A companion argument is typically that what is being proposed, while not perfect, is the best alternative available. There were elements of this in the Payless case and these arguments often prevail. The decision reached demonstrates, however, that there are limits to how far such arguments can go, which should inform future requests for Canadian recognition of foreign DIP orders.
Payless is a well-known footwear retailer based in Kansas that operates nearly 4,400 stores in the US and internationally, including 258 in Canada. Payless Canada Group relies entirely on US Payless entities for managerial functions and direction, overhead services, buying power and sourcing relationships. The assets of Payless Canada Group consist principally of merchandise.
Earlier in April, a number of US Payless entities and the Payless Canada Group (collectively, “Chapter 11 Debtors”) had filed voluntary petitions for relief under Chapter 11 of the US Bankruptcy Code. In the face of no opposition, the Ontario Court, exercising its jurisdiction under Part IV of the CCAA, had no difficulty recognizing the Chapter 11 Debtors’ bankruptcy cases as foreign main proceedings, granting a stay of proceedings in favour of the Chapter 11 Debtors and recognizing various First Day Orders made by the US Bankruptcy Court, except the Interim DIP Order. The latter recognition was opposed by a group of Canadian landlords with multiple locations, whose position was upheld by the Ontario Court in declining to grant recognition of the Interim DIP Order or other DIP-related relief.
The DIP credit agreement required Payless Canada Group to guarantee the DIP credit facility and grant charges against their assets as collateral for the indebtedness under that facility, even though the Payless Canada Group entities are not borrowers or providers of collateral under the pre-filing credit facility, are not borrowers under the DIP credit facility, will not receive any advances under the DIP credit facility and their assets are currently unencumbered.
To minimize the impact on Payless Canada Group’s existing unsecured creditors of the assets of Payless Canada Group becoming collateral for the DIP facility, it was proposed that these unsecured creditors be granted a court-ordered charge ranking ahead of the proposed DIP charge, to a maximum of $1.4 million of pre-filing claims. In addition, the Canadian logistics and freight services provider would be granted protection for pre-filing claims through a critical vendors order and employees would be protected by being paid in the ordinary course and being granted a prepetition wages and benefits order. The Canadian landlords, however, were not offered comparable protection from the impact of the proposed DIP facility; rather, they were being asked to rely on the Chapter 11 Debtors’ “good intentions” to continue operations and pay the landlords in the ordinary course.
As is typical in these cases, the Chapter 11 Entities argued that the Ontario Court should grant the DIP-related recognition relief since this would benefit all stakeholders and, without immediate access to the DIP facility, the Chapter 11 Debtors would be unable to finance their operations and suffer irreparable harm, resulting in disastrous effects on Payless Canada Group, which are unable to survive as a going concern without the US-based Chapter 11 Debtors. The Canadian Information Officer appointed by the Ontario Court reported, among other things, that the creditors of Payless Canada Group did not appear to be materially prejudiced by the terms of the DIP credit agreement or the proposed DIP charge, which though not optimal from a Canadian creditor’s perspective, appeared to be the best alternative available to maintain the operations of Payless Canada Group as a going concern for all stakeholders’ benefit and were preconditions to move forward with a successful restructuring.
Not surprisingly, the Canadian landlords opposed the Canadian DIP recognition relief sought by the Chapter 11 Debtors, largely on the basis that unlike other creditor groups they were not being offered protection in the form of a court-ordered charge from the possible detrimental effects of subjecting the Payless Canada Group to the DIP facility indebtedness and charges.
Regional Senior Justice Morawetz accepted the Canadian landlords’ position and refused to grant the DIP recognition relief. In order for the DIP relief to be approved, he reasoned, “there would have to be adequate protection to ensure that all Canadian creditor groups would not be adversely affected by the grant of the security” (emphasis is the Court’s), which was not what was being proposed. In his view, it would be acceptable to alter the status quo in exchange for the benefits flowing from the DIP facility only if arrangements were made to ensure that all affected Payless Canada Group creditors “were protected to the extent that they could be no worse off if the Recognition Order is granted.” The Court also observed that its role is limited to ruling on the specific relief sought and it is not the Court’s role to propose an alternative solution not contemplated or negotiated by the parties.