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This significant recent decision of the Supreme Court of Canada confirms (i) that a CCAA supervising judge enjoys broad discretion and the necessary jurisdiction to prevent a creditor from voting on a plan of arrangement when the creditor is acting for an improper purpose, and (ii) that litigation funding is not intrinsically illegal and that a litigation funding agreement can be approved by the Court as an interim financing in insolvency. The decision establishes third-party litigation funding as a powerful tool in debtor counsel's toolkit to maximize recovery for company stakeholders.
Introduction
As the number of corporate insolvencies rises - a trend that is accelerating under the current COVID-19 pandemic - courts across Canada are called upon, often urgently, to place corporate debtors under court protection. The purpose of doing so is to allow insolvent debtors some "breathing room" so that they can restructure their businesses and affairs.
In its reasons in 9354-9186 Québec inc. v. Callidus Capital Corp., 2020 SCC 10 ("Bluberi"), released on May 8, 2020, the Supreme Court of Canada ("SCC") provided important guidance relating to insolvency proceedings. This unanimous decision, co-written by Chief Justice Wagner and Justice Moldaver, followed the court's oral judgment of January 23, 2020 overturning the ruling of the Quebec Court of Appeal.
The Bluberi ruling focused on the broad discretion enjoyed by a supervising judge presiding over a Companies' Creditors Arrangement Act ("CCAA") process and on the degree of deference appellate courts should demonstrate on appeal from a judgment of the CCAA court. More specifically, as discussed below, Bluberi establishes a precedent pursuant to which:
- A creditor acting for an improper purpose may be barred from voting on a CCAA plan of arrangement; and
- A third-party litigation funding agreement may be approved as interim financing pursuant to the CCAA.
Litigation funding involves a third-party funding litigation in exchange for a portion of the proceeds resulting from the lawsuit. This type of funding is now broadly accepted and is supported by an expanding litigation financing industry. In affirming the availability of litigation funding in the insolvency context, the SCC has provided an important tool for insolvent debtors that wish to restructure their operations or otherwise maximize value for their creditors.
Interestingly, it took less than two weeks for the same Court of Appeal that was overturned in Bluberi to cite the Bluberi decision with approval in Arrangement relative à 9323-7055 Quebec inc. (Aquadis International) 2020 QCCA 659, in connection with the widely accepted notion that the CCAA can also be used to implement an orderly liquidation of an insolvent business.
The CCAA Process
In November 2015, the debtor companies (formerly known as "Bluberi") filed a petition for the issuance of an initial order under the CCAA.
A contested filingThe CCAA petition was granted by the supervising judge over the objection of the principal secured creditor of Bluberi, Callidus Capital Corporation ("Callidus"), in the context of a bitter dispute in which Bluberi alleged that Callidus had abused its rights as lender and triggered Bluberi's insolvency.
Ernst & Young Inc. (the "Monitor") was appointed to act as monitor of Bluberi under the CCAA. The supervising judge oversaw, with the assistance of the Monitor, a disputed CCAA process, involving several contested hearings, recognition proceedings in the United States under Chapter 15 of the U.S. Bankruptcy Code and a sale and investment solicitation process for Bluberi's assets and business.
Callidus purchases Bluberi's assets
Through the sale process, Callidus purchased the assets of Bluberi by credit-bidding the integrality of its $135.7 million secured debt, save for a remaining portion of $3 million. In so doing, it acquired substantially all the assets of Bluberi, save for the damages claims which Bluberi sought to assert against Callidus in an amount of $200 million (the "Retained Claims"). These Retained Claims were carved out of the purchased assets and remained with the company now known as 9354-9186 Québec inc. The latter then sought funding from third parties to fund its litigation against Callidus.
Callidus' first plan of arrangement voted down
In September 2017, Callidus submitted a plan of arrangement in which it offered a distribution of $2.63 million to Bluberi's unsecured creditors, in return for a complete and final release from all Retained Claims. However, in the course of an epic assembly of creditors (held in a Drummondville hotel, in a room aptly named "Hocus Pocus Circus"), the Callidus plan was voted down by Bluberi's creditors. Although a vast majority of creditors supported the plan, the statutory threshold of two-thirds of the dollar value of all claims was not met because one supplier with a large claim voted against the plan.
The third-party litigation funding agreement
The company formerly known as Bluberi then secured interim financing in the form of a third-party litigation funding agreement ("LFA") with IMF Bentham Limited and its affiliate Bentham IMF Capital Limited (now Omni Bridgeway) ("Omni") to pursue the Retained Claims against Callidus. The LFA followed the standard litigation funding framework and Omni would only receive payment if Bluberi was successful at trial or the matter was settled by agreement. The LFA also provided for a contingency fee payable to the lawyers representing Bluberi. Bluberi applied to the CCAA Court to approve the LFA as an interim financing under the CCAA and to obtain the issuance of a super-priority charge to guarantee the obligations owed to Omni under the LFA.
Callidus' second plan of arrangement: the key dispute arises
However, shortly before that application could be heard, Callidus proposed another, virtually identical, plan of arrangement (the "Second Plan"). This time however, Callidus sought the judge's permission to vote its $3 million secured claim on this Second Plan in the same class as the unsecured creditors, on the basis that its security should be valued at zero.
Supervising judge finds "improper purpose"
The supervising judge determined that Callidus should not be permitted to vote on the Second Plan because it was acting with an "improper purpose", namely to tip the scales of the creditor vote in its favour in circumstances where a virtually identical plan had already been voted down by Bluberi's creditors. As a result, the judge found that the Second Plan had no reasonable prospect of success and it should not be put to a creditors' vote. Instead, the judge authorized Bluberi to execute the LFA and approved of the related super-priority financing charge in favour of Omni.
Appeal to the Quebec Court of Appeal
Callidus and a group composed of certain unsecured creditors of Bluberi appealed the decision of the supervising judge. After granting leave to appeal, the Court of Appeal set aside the judge's order, holding that Callidus should have been permitted to vote on the Second Plan, given that the creditors have a right to vote in their own self-interest, and that the LFA was akin to a plan of arrangement and needed to be brought to the creditors for a vote, rather than being approved as interim financing (which requires only judge approval). Bluberi and Bentham sought and obtained leave to appeal to the SCC. The Monitor supported the position adopted by the entity formerly known as Bluberi at first instance, before the Court of Appeal and before the Supreme Court of Canada.
The Supreme Court of Canada's Ruling
The Bluberi case displays a rather unique fact pattern which raises several interesting legal issues. The SCC addressed two of them in its reasons, answering both questions in the affirmative (as had the supervising judge):
- Does a supervising judge have the discretion to bar a creditor from voting on a plan of arrangement if he or she determines that the creditor is acting for an improper purpose?
- Can the LFA be approved by the Court as an interim financing, pursuant to s. 11.2 of the CCAA (as opposed to a plan of arrangement, which would require a vote of Bluberi's creditors)?
The case also raised other issues, including whether Callidus is "related" to Bluberi within the meaning of s. 22(3) of the CCAA; and whether, if permitted to vote on its plan, Callidus should be ordered to vote in a separate class from Bluberi's other creditors (see CCAA, s. 22(1) and (2)). However, given the SCC's conclusion that the supervising judge did not err in barring Callidus from voting on the Second Plan on the basis that Callidus was acting for an improper purpose, the SCC declined to address either of those issues.
Judicial discretion and improper purpose
The SCC took the opportunity to clarify the nature and scope of a supervising judge's discretion in CCAA matters. It observed that:
- Section 11 of the CCAA provides supervising judges with broad discretion to make a variety of orders; and that
- Those powers are justified, at least in part, by the fact that the CCAA process is overseen by a single supervising judge, who, with the assistance of the monitor, acquires extensive insight into a debtor's activities, including its relationships with its various stakeholders.
The SCC concluded that jurisdiction exists under s. 11 to bar a creditor from voting on a plan of arrangement where the creditor is acting for an improper purpose.
When should the discretion be exercised?
In the absence of a specific provision in the CCAA which determines when a creditor who is otherwise eligible to vote may be barred from voting (and given that, as a whole, the CCAA regime recognizes creditor participation in decision-making as an integral facet of the workout regime), the SCC held that creditors should be barred from voting only where the circumstances demand such an outcome.
In that regard, the Court further confirmed that the exercise of judicial discretion must further the remedial objectives of the CCAA and be guided by the baseline considerations of appropriateness, good faith and due diligence. Where a creditor is seeking to exercise its voting rights in a manner that frustrates, undermines, or runs counter to those objectives, the supervising judge has the discretion to bar that creditor from voting on the plan.
Comparison with the BIA
A similar discretion is available under the other statute that can be used to implement a corporate restructuring, namely the Bankruptcy and Insolvency Act ("BIA"), as recognized by the Nova Scotia Court of Appeal in Laserworks Computer Services Inc. (Bankruptcy), Re. The SCC found that the existence of such a discretion under the BIA militates in favour of the existence of a similar discretion under the CCAA, particularly since (i) this would be consistent with the recognition that the CCAA is more flexible and offers greater judicial discretion than the BIA, and (ii) the SCC previously recognized the benefits of harmonizing the two statutes.
The exercise of discretion by the supervising judge in this case
In the circumstances of this case, the supervising judge did not err in preventing Callidus from voting on the Second Plan, particularly since Callidus was seeking to strategically value its security at nil in order to control the outcome of the vote, thereby circumventing the will of the unsecured creditors. The judge's decision needed to be approached with the appropriate posture of deference, bearing in mind that the judge was intimately familiar with the Bluberi CCAA proceedings, having presided over them for over 2 years, received 15 reports from the Monitor and issued approximately 25 orders.
On this key point, the SCC cited the Monitor's Factum with approval:
The Court of Appeal's error
According to the SCC, the Quebec Court of Appeal, in determining whether the supervising judge adequately exercised his discretion, did not correctly characterize the basis of the decision on appeal. Although the Court of Appeal seized upon the supervising judge's somewhat critical comments relating to Callidus' conduct and goal of being released from the Retained Claims as being incapable of grounding a finding of improper purpose, the crux of the issue was the attempt at manipulating the creditor vote, and nothing in the reasons of the Court of Appeal addressed this.
Conclusion on the issues of discretion and deference
In reaching this result, the SCC confirmed the well-established principle that appellate intervention in CCAA matters will be justified only if the supervising judge erred in principle or exercised his or her discretion unreasonably. A high degree of deference is critical to CCAA proceedings and the SCC has delivered a clear message that appellate intervention should be limited to exceptional cases.
Approval of litigation funding as interim financing
Insolvent corporate debtors frequently resort to interim financing (also known as "debtor-in-possession" or "DIP" financing) to finance a restructuring. In order to entice lenders to lend funds to an insolvent entity, insolvency statutes provide courts with the ability to order a super-priority charge in favour of the interim lender that ranks above the security interests registered by secured lenders on the debtor's assets. An interim financing requires only the approval of the court on notice to secured lenders.
An LFA can be an interim financing
The issue in Bluberi was that the supervising judge approved the LFA with Omni as an interim financing under s. 11.2 of the CCAA but the Quebec Court of Appeal overturned that decision, as it found that the LFA was a plan of arrangement, and therefore, that it should be submitted to a vote of Bluberi's creditors prior to being submitted to the Court for approval. The SCC, weighing in on the issue, upheld the supervisory judge's decision, finding that interim financing is a flexible tool that can take on a range of forms, and that third-party litigation funding may, in appropriate cases, be one such form.
Determining when LFAs are plans of arrangement
The SCC also commented on the notion of "plan of arrangement" finding that the latter requires at least some compromise of creditor's rights and therefore, that a third party litigation funding agreement aimed at extending financing to a debtor company to realize on a litigious claim does not necessarily constitute a plan of arrangement. The Court held that is up to the supervisory judge to determine whether, in the circumstances of the case, a third-party litigation funding agreement contains terms that effectively convert it into a plan of arrangement. So long as the agreement does not contain such terms, it may be approved as interim financing pursuant to s. 11.2 of the CCAA.
The SCC in Bluberi did state, however, that
and that a supervising judge could determine that
SCC upholds Crystallex
In reaching its conclusions, the SCC followed the Ontario Court of Appeal decision in Crystallex, a case where third-party litigation funding was approved as interim financing to allow an insolvent Canadian mining company under CCAA protection an opportunity to pursue a US$3.4 billion arbitration claim against Venezuela, after the expropriation of its assets in that country. The argument pursuant to which the litigation funding agreement was truly a plan of arrangement as opposed to interim financing had also been brought - and defeated - in Crystallex. The SCC confirmed that the Quebec Court of Appeal had erred in distinguishing Crystallex from Bluberi.
Conclusion on the litigation funding issue
As noted above, the SCC deferred to the supervising judge's determination that the LFA in this case was correctly characterized as a form of interim financing rather than as a plan of arrangement.
Key Takeaways
The key takeaway from Bluberi is therefore that each case must be assessed on its facts and that the supervising judge retains the discretion to decide if a proposed litigation funding agreement should be presented to creditors along with a plan of arrangement.
The SCC found that the supervising judge, in approving the LFA as interim financing, although he did not canvass each of the factors set out in s. 11.2(4) CCAA individually before reaching his conclusion, committed no error in principle, nor did he err in exercising his discretion. The Quebec Court of Appeal, to the extent it held otherwise, failed to afford the supervising judge the necessary deference. The Court of Appeal's insistence that the LFA was a plan of arrangement failed to take into consideration that Bluberi's litigation claim is akin to a "pot of gold" and that
Stepping back, Bluberi establishes litigation finance as a powerful tool for debtor's counsel. In addition to affirming the efficacy of litigation finance as the U.S., U.K. and Australian courts have done, the SCC has provided guidance on this type of financing ought to be assessed and approved in an insolvency context. Bluberi will facilitate the resort to litigation finance for insolvent companies that seek to maximize the value of the assets available for distribution to creditors.
Originally published 3 juin 2020
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