CCAA Versus Chapter 11—An Examination of the Role of the Monitor

Overview

The principal Canadian restructuring statute, the Companies’ Creditors Arrangement Act (“CCAA”), evolved from the provisions of the English corporations statute dealing with corporate reorganizations. Despite their different origins, the objectives and processes of the CCAA and Chapter 11 of the U.S. Bankruptcy Code are remarkably similar. A fundamental distinction, however, that colors the entire Canadian process is the mandatory appointment of a “Monitor” and the absence of a mandatory unsecured creditors’ committee. In order to understand the Canadian approach to restructuring, an American practitioner must understand the role of the Monitor.

A Brief History of the CCAA

The CCAA was passed during the Great Depression to provide a means by which insolvent companies could avoid liquidation. The Act was modeled on section 153 of the English Companies’ Act of 1929, and comprised only 20 provisions. The proceeding was commenced by filing the proposed plan of compromise or arrangement (the “Plan”) and asking for meetings of the affected classes of creditors to be ordered. If approved by the requisite majority of creditors, the Plan was submitted to the court for approval. A stay of judicial proceedings would be in place between the commencement of the CCAA proceeding and the failure or approval of the Plan. The process was not a lengthy one. There is very little jurisprudence dealing with the CCAA from this early period. After the 1940s, the Act essentially became dormant until the early 1980s.

Until the early 1990s, the alternate restructuring process under the Bankruptcy Act (now the Bankruptcy and Insolvency Act) could not stay or compromise secured creditors. In the early 1980s, faced with a severe economic downturn in Western Canada, creative counsel realized that the CCAA could be used to stay and compromise secured creditors and, thus, was a powerful restructuring tool.

The next important evolution in the history of the CCAA lay in the courts’ approach to the CCAA when its use was revived in Eastern Canada in the mid- to late-1980s, largely to deal with downturns in the retail and real estate sectors. The courts regarded the legislation as remedial in that it avoids the devastating social and economic affects of a liquidation. The courts held that the Act is to be given a wide and liberal construction so as to enable it to effectively serve the remedial purpose. The skeletal nature of the statute opened the door to creativity and flexibility. Canadian practitioners observed restructuring tools contained in Chapter 11 proceedings, such as filing for a stay without having a Plan, DIP financing and the right to reject contracts, and assimilated those tools (with some differences) into the Canadian process. This was accomplished on an ad hoc basis through court orders grounded in a broad interpretation of the stay of proceeding provisions in the CCAA or the inherent jurisdiction of the court.

As part of this evolution, perhaps influenced by the Chapter 11 process, the practice of filing a Plan at the outset of the proceeding fell away. The courts became satisfied if the initial filing disclosed an outline of an anticipated Plan. Quite quickly, even that requirement disappeared. Currently, assuming the debtor company meets certain thresholds, the court will grant a broad stay of proceeding in order to allow a Plan to be developed and negotiated, and ultimately voted upon. This extends the length of a typical CCAA case significantly from what was initially contemplated.

The CCAA underwent significant amendment in 1997 and further amendments became effective in 2009. Despite the amendments, the CCAA remains more of a framework statute than a detailed code. It retains significant flexibility.

Similarities between the CCAA and Chapter 11 Processes

From a functional perspective, the CCAA and Chapter 11 processes are remarkably similar:

•  They are both debtor in possession restructurings— usually initiated by the debtor company.

•  There is a broad stay of judicial and non-judicial proceedings at the commencement of the proceeding which remains in place until the termination of the proceeding, and it is very difficult to obtain relief from the stay.

•  There is an ability to raise interim financing during the restructuring through DIP financing.

•  There is a toolkit of powers to assist in a restructuring, such as the restriction of the ability of counterparties to terminate contracts, the ability of the debtor to reject (repudiate) contracts and the ability, in certain circumstances, to force assignments of contracts.

•  There are rules with respect to recovery of preferential payments made prior to the filing.

•  There is an ability to sell assets (or the entire business of a debtor) prior to a Plan.

•  There is great flexibility in crafting a Plan, including offers of specific amounts of money, pots of assets or debt to equity swaps.

•  A Plan can contain provisions protecting directors, officers and other third parties, in appropriate circumstances.

•  There is an ability to consolidate estates.

•  The proposed Plan is voted on by creditors in classes.

•  If the requisite approval of creditors is obtained, the Plan is subject to the approval of a court based upon the commercial reasonableness of the Plan.

In the view of the authors, the principal functional differences between the two systems lies in the appointment, in Canada, of a court officer, a Monitor, and the absence of a mandatory unsecured creditors committee.

The Origin and Evolution of the Monitor

The original CCAA did not contain the concept of a “monitor.” There is no such person in the English statute from which it was derived. In one of the first CCAA cases in the early 1980s, one of the operating lenders expressed concern about leaving existing management of the insolvent debtor in control during the course of the proceeding. In order to assuage this concern, the debtor company contracted with the trustee in bankruptcy subsidiary of an accounting firm to monitor the debtor company during the course of the restructuring, with a mandate to inform the operating lenders of any untoward activity. Eventually, it became a routine practice to appoint a Monitor in CCAA filings and provide for this in the initial order. The scope of the mandate of a Monitor expanded in a schizophrenic way. Not only was a Monitor to be a watchdog for the court and creditors, but in many cases the Monitor was also charged with assisting the debtor in the development of its Plan and providing comments on the Plan to the court.

In the 1997 amendments to the CCAA, the appointment of a Monitor was made obligatory. The basic powers and obligations of the Monitor are now set out in section 23 of the CCAA. In addition, further powers or obligations of the Monitor usually are contained in the initial orders made when a CCAA case is commenced.

The Duties and Functions of the Monitor—CCAA Provisions

The Monitor is an officer of the court with a duty to be neutral and to act in the best interests of all concerned. It must act independently of any of the stakeholders, balancing the interests of all stakeholders while fulfilling its mandate. Section 25 of the CCAA provides that the Monitor must act honestly and in good faith and comply with a prescribed code of ethics.

The basic duties and functions of a Monitor are set out in section 23 of the CCAA. Those duties can be summarized as follows:

•  To review the debtor’s cash flow statements, business and financial affairs and to report to the court and creditors as specified by the court or, without delay, after ascertaining a material adverse change in the debtor’s financial circumstances.

•  To advise the court, at any time during the proceedings, if the Monitor is of the opinion that it would be more beneficial to the debtor’s creditors if the debtor were to be declared bankrupt (in Canada the word “bankruptcy” means a Chapter 7–like liquidation).

•  On the filing of a Plan, to advise the court and creditors on the reasonableness and fairness of the Plan.

•  To perform any other function in relation to the debtor that the court directs.

As a court officer, the reports of the Monitor (which are unsworn) constitute evidence in the CCAA proceeding. The reports of the Monitor constitute a primary means to disseminate information about the debtor to the court and creditors. The court gives deference to the recommendations of a Monitor contained in such reports.

The CCAA also contains certain statutory protections for Monitors. Monitors are not personally liable for matters that arose before their appointment. Their liability in respect of environmental matters is also limited. Monitors are not liable with respect to the contents of their reports if made in good faith and with reasonable care.

Duties and Functions of Monitors—Court Ordered Provisions

In addition to the duties and functions of the Monitor set out in the CCAA, the model initial order used in the province of Ontario (other provincial model initial orders are similar) contains the following significant additional power: The Monitor is directed and empowered to “advise the Applicant [debtor] in its development of the Plan and any amendments to the Plan.”

The Schizophrenic Nature of the Monitor’s Role

In summary, while being required to act neutrally and in an independent manner, the Monitor is required to:

•  Act as a watchdog monitoring the affairs of the debtor and blowing the whistle if, at any point, there is a material adverse change or bankruptcy would be preferable.

•  Assist the company in the development of its Plan.

•  Advise the court on the reasonableness and fairness of that Plan.

It would seem to be impossible to carryout this seemingly contradictory mandate in a neutral and independent manner.

However, the firms that regularly act as Monitors in Canada (less than 10) are very experienced and skilled in carrying out their role. Typically, with respect to any step in the restructuring, the Monitor will work with the debtor to reach consensus. If consensus is achieved, the Monitor works with the debtor in disseminating information to relevant stakeholders and building a consensus amongst the stakeholder groups. If a sufficient consensus is achieved, the Monitor recommends a particular step to the court. On the surface it appears that most matters proceed on consent in Canada; however, the consent often is the result of the mediation of positions facilitated by the Monitor. If a sufficient consensus is achieved and the support of the Monitor is expressed, it is very difficult (but not impossible) to successfully oppose the step being taken by the debtor.

Unsecured Creditor Committees in Canada

There is no requirement to constitute a committee of unsecured creditors in Canada, and such committees are not common. Canadian courts will, in their discretion, appoint representative counsel (and sometimes also financial advisors) to represent the interests of vulnerable constituencies, such as retirees or employees, and require the debtor to bear the costs. The courts also recognize ad hoc committees of creditors such as noteholders and bondholders—but rarely require the debtor to fund such committees.

As a result of the most recent amendments, the CCAA contains an express provision allowing the court to appoint committees of creditors and, in appropriate circumstances, to secure payment of the fees of advisors from the assets of the debtor. This provision is merely a codification of past practice and it is doubtful that it will become common practice to appoint committees of unsecured creditors or to provide for funding such committees.

It is the understanding of the authors, viewed through a Canadian lens, that a primary function of unsecured creditor committees under Chapter 11 is to challenge and question steps in the proceeding being proposed by the debtor. There are broad powers of deposition and information gathering at the disposal of the committees. The vigilance of the unsecured creditors committee acts as a check and balance to the maneuvering of the debtor and, in some cases, drives value to the unsecured creditor constituency. Thus, functionally, it can be said that the role of a Monitor and an unsecured creditors committee is similar. They are both means used to police the debtor. A functional distinction between the two is that the Monitor is required to be neutral and reasonable while unsecured creditor committees are expected to take aggressive positions on behalf of the unsecured constituency of creditors.

Possible Concerns with Respect to the Role of the Monitor

Canadian insolvency practitioners are proud of the CCAA restructuring process. We regard our system as flexible, reasonably expeditious and significantly less expensive than Chapter 11 proceedings. In the authors’ view these qualities arise, in large part, from the role of the Monitor and the absence of aggressive unsecured creditor committees. One can question whether the Canadian process trades speed and cost off against recovery to unsecured creditors.

The following are issues and concerns that American clients have raised with respect to the role of the Monitor:

•  Independence—There are two concerns in this regard. The first relates to the small number of Canadian restructuring professionals and the second relates to the role of the Monitor. There are only about 10 firms that act as Monitors in any material restructuring. Similarly, there is a relatively small amount of law firms with sophisticated restructuring practices. These law firms are stakeholder agnostic: they will act for debtors, court officers and creditors in different proceedings. It is not uncommon for a law firm to be acting for the Monitor in one proceeding and act for a creditor in another proceeding where the same firm is the Monitor. This would not be countenanced in a Chapter 11 proceeding but is a reality given the size of the Canadian marketplace. The second concern arises from the role of the Monitor. From a perception standpoint it is difficult for unsecured creditors to accept that the Monitor can work with the debtor in developing a Plan and then be required to express an objective recommendation to the court with respect to the Plan—or, worse, recommend that the proceedings be terminated.

•  Dissemination of information—A lot of the information provided during a restructuring proceeding is provided through Monitor reports. These reports are generally neutral ones taking reasonable positions. It is difficult to cross-examine a Monitor on a report and it is uncommon to have deposition rights with respect to the debtor. Given the perception problem arising from the Monitor working with the debtor in developing a Plan, it is sometimes difficult for American clients to accept that they are getting adequate access to all the information necessary to advance a position. They are concerned that the Monitor is not a font but, rather, a filter of information.

•  In the absence of mandatory, funded unsecured creditors committees, who is the champion of unsecured creditors in Canada? Who is fighting, in an organized and united way, to squeeze value out for unsecured creditors? It is not the Monitor. The Monitor is mandated to be neutral and reasonable.

Conclusion

It is not clear to the authors whether one system is better than the other. Sacrificing maximization of unsecured creditors’ returns (if that in fact occurs in Canada) for speed and cost savings may be a superior result to society than the alternative. That is a matter for professors and legislators to study. The purpose of this article simply is to explain the Canadian system to American insolvency practitioners and to point out some concerns. The Canadian process remains flexible and fluid. If problems or abuses are observed with respect to the role of the Monitor or the need for an unsecured creditors committee, those concerns can be addressed on an ad hoc basis, or through the organic evolution of the roles of Monitors and unsecured creditors committees in Canada.