New Concerns for Bondholders, Lenders and Other Creditors Following SCC's Indalex Decision

On February 1, 2013, the Supreme Court of Canada (SCC) released its much-awaited decision in the Indalex case.¹ While the central issue in Indalex was the priority of wind-up deficiencies in defined benefit pension plans versus court-ordered debtor-in-possession (DIP) financing charges under the Companies' Creditors Arrangement Act (Canada) (CCAA), the SCC also considered whether claims for wind-up deficiencies are covered by deemed trusts under the Ontario Pension Benefits Act (PBA). This issue is of particular importance to lenders, bondholders and other creditors both in the ordinary course and in an insolvency or restructuring.

The Ontario Court of Appeal had ruled that the assets of Indalex were encumbered by a deemed trust pursuant to section 57(4) of the PBA in favour of the pension plan beneficiaries in respect of the wind-up deficit in the Indalex pension plan, and therefore had priority over the court-ordered DIP charge in Indalex's CCAA proceedings with respect to the remaining asset value.

While the SCC overturned the Ontario Court of Appeal's decision on the central issue, holding that the court-ordered DIP charge under the federal CCAA ranks ahead of the deemed trust under the provincial PBA, four of the seven judges on the panel also expressed the view that the assets of Indalex were encumbered by the deemed trust under the PBA to the extent of the pension wind-up deficiency.

This decision could have important implications for lenders, bondholders and other creditors, both secured and unsecured, and appropriate caution and additional protective measures may need to be taken when lending to or dealing with Canadian debtors with operations in Ontario with significant defined-benefit pension plans. The same concerns would not apply to defined-contribution plans and may not apply in certain other parts of Canada.

Deemed Trusts Under the Pension Benefits Act (Ontario)

Section 57(4) of the PBA provides, where a pension plan is wound up, for the creation of a deemed trust with respect to assets of the debtor in an amount equal to unpaid employer contributions accrued to the date of wind-up. Prior to the Court of Appeal decision in Indalex, it was generally accepted (based on prior caselaw in Ontario²) that a wind-up deficiency (i.e., the difference between the value of the assets in the pension plan and the total amount necessary to satisfy the obligations to the pension members as at the wind-up date) unrelated to the failure to make regularly scheduled statutorily mandated payments was a regular unsecured claim not covered by the deemed trust.

While a minority of the SCC agreed with this previous interpretation, a majority of the judges, in different reasons, expressed the view that the deemed trust would extend to the wind-up deficiency. For bondholders, unsecured lenders and other creditors, this now means that you can expect pension administrators of defined benefit plans to assert priority claims for wind-up deficiencies in restructurings or liquidations. One might also expect to see a contracting of available unsecured (and even possibly secured) bank and bond financing for companies with defined-benefit plans, even where they are not approaching insolvency, since lenders may wish to hedge against the above new claims for priority. On the other hand, it should be expected that the creditor side will assert that the views expressed by four of the seven Judges with respect to the deemed trust for wind-up deficiencies were not definitive as to that issue, as the Court did not actually have to make a determination on that issue in Indalex.

Priority of Deemed Trust

On the central issue of the priority of the DIP charge under Indalex's CCAA Initial Order versus the deemed trust for its pension wind-up deficiency, the SCC held that the DIP charge ranked ahead of the claimed deemed trust based on the fact that the federal CCAA is paramount to the provincial PBA in the event of a direct conflict. The Court also noted that the whole concept of a trust claim for wind-up deficiency only becomes relevant where the pension plan is actually wound up.

The SCC's decision was not specifically focused on the issue of where any deemed trust for a pension wind-up deficiency would rank in relation to secured interests other than the DIP charge, and therefore secured creditors will have to consider the legal ranking of their security relative to a deemed trust under the PBA, including such considerations as the wording of the relevant security statute and other applicable legislation, such as the CCAA or the Bankruptcy and Insolvency Act. The answer may vary from province to province, or federally.

Need for Proactive Steps

The full implications of Indalex remain to be seen. It is very early. There are however some immediate proactive steps that lenders, bondholders and other creditors may wish to consider as a result in situations involving debtors with defined-benefit pension plans in Ontario (and perhaps elsewhere). These include:

1. Reviewing lending agreements, bond indentures, security (if any) margin rules with respect to underlying assets and other covenants and considering whether availability can or should be reduced or rules or covenants changed in light of the possible claim to priority for the wind-up deficiency.
2. Being vigilant in monitoring the borrower's defined-benefit pension plan and seeking appropriate and frequent reporting in order to try to determine the rough quantum of any deficiency on an ongoing basis. Of course, such an attempt could only be a very rough one, since a great deal more information is needed to determine the final, statutory wind-up deficiency, which could well be greater than even the most careful outside analysis is able to estimate.

The Spectre of Conflict in Fiduciary Duty

Finally, given that the SCC noted the potential conflict between the debtor company acting as the administrator of its pension plan (which is common) that may be in deficit and acting in the interests of the company, including its creditors and other stakeholders in approaching insolvency, bondholders, lenders and other creditors might expect that an insolvent debtor may be less willing to take steps that, although they might save the company, could be attacked later for not having protected the pensioners sufficiently. In the context of all of the competing interests that often work against a successful restructuring, it appears that the SCC has allowed a renewed emphasis upon yet another such potential impediment.

Notes

1. Sun Indalex Finance, LLC v. United Steelworkers, 2013 SCC 6
2. See, for example Toronto Dominion Bank v. Usarco (1991), 42 ETR 235 (Ont Gen Div); and the Ontario Court of Appeal decision in Re Ivaco Inc. (2006), 83 OR (3d) 108 (Ont C.A.)