DECEMBER 2013 BANKING

Supreme Court of Canada Decision in Sun Indalex: Good News For Some, But Not For Others Page 1

Mortgage Fraud And Recourse For Victims Of LawyersPage 3

When May Remediation Orders be Compromised in a CCAA Restructuring? Page 6

Alberta Court Won’t Allow Lenders to Have Their Cake and Eat It Too: Warnings from a Recent Foreclosure CasePage 8

Banking LawyersBetteridge, Robert D. (Bob) 403-260-0188 ................................................................................................................................rdb@bdplaw.comCarleton, J. Robert 403-260-0206 ...................................................................................................................... rcarleton@bdplaw.comDeLuca, G. Dino 403-260-0211 ...............................................................................................................................gdd@bdplaw.comFehr, Trish M. 403-260-0212 ...............................................................................................................................pmf@bdplaw.comGrout, A. David 403-260-0326 ...........................................................................................................................dgrout@bdplaw.comIonescu-Mocanu, Simina 403-260-0231 .......................................................................................................................sionescu@bdplaw.comJohnson q.c., Cal D. 403-260-0203 ................................................................................................................................ cdj@bdplaw.comKuzma, Andrew 403-260-0170 .........................................................................................................................akuzma@bdplaw.comLangdon, Margot D. 403-260-0205 ............................................................................................................................... mdl@bdplaw.comMartin, Christie E. 403-806-7870 ......................................................................................................................... cmartin@bdplaw.comMisri, Nathaniel S. 403-260-0165 .......................................................................................................................... nmisri@bdplaw.comPybus, Kathy L. 403-260-0196 ................................................................................................................................ klp@bdplaw.comSmith, Nancy D. 403-260-0124 ......................................................................................................................... nsmith@bdplaw.comTremblay, Janie 403-260-0355 .................................................................................................................... jtremblay@bdplaw.com Wilmot, John A. 403-260-0117 ............................................................................................................................... jaw@bdplaw.com

Banking and other issues of On Record are available on our web site www.bdplaw.com

Banking, Editors-in-ChiefCal D. Johnson, q.c.cdj@bdplaw.com403-260-0203Simina Ionescu-Mocanusionescu@bdplaw.com403-260-0231

Banking, Managing EditorRhonda G. Wishartrwishart@bdplaw.com403-260-0268

Contributing Writers and Researchers:Carole Hunter, Simina Ionescu-Mocanu, Cassandra Calder, Alison Koper and Sakeb Nazim

ContactFor additional copies, address changes, or to suggest articles for future consideration, please contact the Managing Editor.

General NoticeOn Record is published by BD&P to provide our clients with timely information as a value-added service. The articles contained here should not be considered as legal advice due to their general nature. Please contact the authors, or other members of our Banking team directly for more detailed information or specific professional advice.

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On Record Contents:

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Supreme Court of Canada Decision in Sun Indalex

Good News For Some, But Not For OthersBy Carole Hunter, Simina Ionesu-Mocanu and Sakeb Nazim, Student-at-Law

IntroductionOn February 1, 2013, the Supreme Court of Canada (“SCC”) released its long awaited decision in Sun Indalex Finance, LLC v. United Steelworkers1 (“Sun Indalex”). In doing so, the SCC overturned the Ontario Court of Appeal’s controversial decision. The SCC confirmed that a secured lender that provides funding to an insolvent entity in an insolvency or bankruptcy proceeding (sometimes called a debtor in possession (“DIP”) lender) receives a super priority charge. The charge ranks superior to the deemed trust created in favour of pension fund beneficiaries under the Ontario Pension Benefit Act (“PBA”) in a Companies’ Creditors Arrangement Act (“CCAA”) restructuring. Although the decision restored the status quo by providing certainty to DIP lenders and debtors seeking DIP financing, the decision raises significant concerns for other secured creditors and employers with defined benefit pension plans.

Background Indalex Limited (“Indalex”) was the administrator of two registered defined benefit pension plans. One of the plans was in the process of being wound up when the CCAA proceedings commenced. The other had been closed but not wound up. Both pension plans were underfunded with estimated wind-up deficiencies of $1.8 and $3.0 million and impacted 49 employees of Indalex. On April 3, 2009, Indalex commenced its restructuring proceedings under the CCAA. Less than a week later, Indalex sought and obtained authorization to borrow US$24.4 million (the amount was later increased to US$29.5 million) from DIP lenders to finance its restructuring. The DIP financing was secured by a court-ordered super-priority charge over the claims of all other creditors, including statutory deemed trusts.

The deemed trust provisions in the PBA provide that amounts payable by an employer in respect of its pension plan obligations

are deemed to be held in trust for the plan beneficiaries. In the ordinary course and absent a bankruptcy, these amounts therefore enjoy priority over the employer’s other creditors’ claims. At the motion seeking approval of the sale of substantially all of Indalex’s assets and an interim distribution of the sale proceeds to the DIP lenders, Indalex’s pension beneficiaries objected to the distribution. They asserted that their claims ranked ahead of the DIP lenders’ claims on the basis of the deemed trust provisions contained in the PBA. As a result, the Court directed that a portion of the sale proceeds be retained so that the issues raised by the plan beneficiaries could be dealt with at a later date.

In its decision, the Ontario Court of Appeal held that: (i) the PBA deemed trust applies to the entire amount the employer is required to pay under the pension plan, including the wind-up deficiency; (ii) the PBA deemed trust has priority over the court-approved DIP charge;

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(iii) Indalex breached its fiduciary duty to the plan beneficiaries by taking actions, including applying for CCAA protection and seeking approval of the DIP loan and priority charge, which had the potential to adversely affect the pension plan beneficiaries; and (iv) the appropriate remedy for the breach of fiduciary duty was to impose a constructive trust over the proceeds from the sale of Indalex’s assets.

The SCC Decision and Its ImplicationsThe three primary issues that the SCC addressed were: (a) whether the wind-up deficiencies are included in the statutory deemed trust under the PBA; (b) whether the deemed trust ranks above the court-ordered super priority DIP charge; and (c) whether Indalex had breached its fiduciary duty to the plan beneficiaries and, if so, whether the imposition of a constructive trust was the appropriate remedy.

a) PBA deemed trust applies to wind-up deficiencies

An employer’s liability on the winding-up of a pension plan has two components. First, the employer must pay all amounts that are due or have accrued, and that have not been paid into the pension fund (i.e. the current service costs). Second, the employer must pay all additional sums to the extent that the assets of the pension fund are insufficient to cover the value of all immediately vested and accelerated benefits and grow-in benefits. This latter liability is known as the “Wind-up Deficiency”.

The SCC agreed with the Ontario Court of Appeal’s interpretation of the scope of the deemed trust provisions under the PBA by confirming that the deemed trust would cover not only current service costs that are due and payable, but also any Wind-up Deficiency.

b) DIP charge supersedes the PBA deemed trust

In rendering its decision, the SCC overturned the Ontario Court of Appeal’s finding and affirmed the super-priority position of the DIP lender’s charge over the PBA deemed trust in the context of a CCAA restructuring. The SCC based its decision on the doctrine of paramountcy, which renders provincial legislation inoperative where it conflicts with federal legislation. The SCC also noted that not granting DIP lenders super priority would frustrate the purpose of the CCAA. To that end, the SCC considered the policy impact of its ruling as the first-ranking priority of a DIP lender’s charge is often the main incentive of a lender’s decision to finance an insolvent debtor who has sought CCAA protection. Without the availability

of DIP financing, insolvent corporations in need of such financing might simply pursue a bankruptcy rather than attempting to restructure their affairs, resulting in job losses and other negative impacts on the economy.

The SCC’s decision did not focus on where a Wind-up Deficiency would rank in relation to secured lenders other than a DIP lender. This may mean that any such other secured lender may risk ranking behind the Wind-up Deficiency if a wind-up is initiated after it has advanced credit. In a CCAA proceeding, secured lenders should, however, note that the PBA deemed trust only applies to accounts and inventory and their proceeds.2 Other assets are not subject to the deemed trust.

c) Constructive trust is not the remedy for breach of fiduciary duties

The SCC held that where an employer also acts as a pension plan’s administrator (which will be the case in most single-employer private sector pension plans) the employer owes a fiduciary duty to the plan beneficiaries. This duty includes avoiding conflicts of interest. A conflict of interest occurs when there is a substantial risk that the employer/administrator’s fiduciary duties owed to the plan beneficiaries would be materially and adversely affected by the employer/administrator’s duties to the corporation. The SCC rejected the “two hat” argument advanced by Indalex and the Monitor which would have effectively allowed the company to avoid considering any conflict of interest while it was wearing its “corporate hat”, and making decisions for the benefit of the corporation.

In reviewing this issue, the SCC found that, in Indalex’s case, merely seeking CCAA protection without adequate notice or making a bankruptcy application did not constitute a breach of the fiduciary duty to the plan beneficiaries. The conflict arose when the company began to take actions in the CCAA proceedings which could adversely impact the interests of the plan beneficiaries. Indalex breached its fiduciary duties because it did not: (i) give reasonable notice of its motion to seek DIP financing to the plan beneficiaries; or (ii) take steps to ensure that the plan beneficiaries were properly represented in the proceedings.

However, despite Indalex’s breach of its fiduciary duties, the SCC held that imposing a constructive trust was not the appropriate remedy. A constructive trust would only be appropriate where a wrongdoer’s acts give rise to an identifiable asset that is directly related to the wrong committed or if the wrong can

be traced to such property. Here, the pension plan beneficiaries failed to show that Indalex’s breach of its fiduciary duty resulted in any assets being placed in Indalex’s hands (i.e. the breach of fiduciary duty did not give rise to the sale proceeds being retained by the Monitor).

RecommendationsThe SCC in Sun Indalex provided no guidance as to the steps that other secured lenders should take to protect their interests against a Wind-up Deficiency. Therefore, it would be prudent for secured lenders to structure their credit agreements with a borrower having a defined benefit pension plan so as to possibly provide advance warning before the borrower encounters serious financial difficulties. This can be done by implementing stringent reporting requirements regarding the debtor’s affairs, particularly with respect to reporting on pension liabilities.

An employer who acts as a pension plan administrator in the context of (i) a CCAA insolvency restructuring, and (ii) DIP financing, must consider its fiduciary duties and the impact that any decisions made in the course of the restructuring may have on the plan beneficiaries. The employer must take measures to avoid conflicts of interest, but if a conflict of interest arises, the employer must bring the conflict to the attention of the court and take steps to ensure that pension plan beneficiaries have independent legal representation at hearings that directly affect their interests.

Finally, it is worth noting that although the Sun Indalex ruling dealt with Ontario pension legislation, the decision is applicable in Alberta by virtue of section 51 of the Alberta Employment Pension Plans Act. The Alberta legislation contains analogous language to its Ontario counterpart and also imposes a deemed trust for employer contributions in regards to current service contributions, as well as funds payable on a wind-up. This analysis would also apply to other provinces to the extent that such provinces have similar legislative provisions in regards to pension plans and deemed trusts.3

Footnotes

1 [2013] S.C.J. No. 62 This statement is based on the wording of the Ontario

PPSA and there is no similar provision in the Alberta PPSA.3 Note that the decision may not be relevant in Quebec because

there are no statutory deemed trust provisions for pension deficits in Quebec legislation. Also, in Quebec, pension plans are administered by pension committees. Conflicts of interests or breaches of fiduciary duties are therefore unlikely to arise in the same context as in Sun Indalex, since the role of the employer with a private pension plans in Quebec differs from those of other provinces.

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Mortgage Fraud And Recourse For Victims Of Lawyers By Sakeb Nazim, Student-at-Law

In June 2013, Bank of Montreal (“BMO”) settled with nearly 160 parties it sued in connection with a sprawling case of mortgage fraud in Alberta, believed to be the largest in Alberta history. Between 2006 and 2007, hundreds of people, mostly new immigrants, were recruited to apply for about $70 million in falsely inflated mortgages involving more than 200 properties. BMO claimed that the fraud cost it over $30 million. The fraud was carried out by over 325 people, including mortgage brokers, appraisers, realtors, bank employees and lawyers. Although BMO is the only bank that pursued legal recourse aggressively, reports indicate that the scope of the mortgage fraud may have been much larger and affected most of the major Canadian banks. In February 2012, Equifax claimed to have uncovered roughly $400 million in mortgage fraud across Canada in 2011 alone. However, neither the Land Title Office nor the Real Estate Council of Alberta collects statistics quantifying mortgage fraud in Alberta.

Among those who settled with BMO were 17 Alberta lawyers who were sued for negligence, or for their alleged roles in the mortgage fraud. Ten of the lawyers faced a range of sanctions imposed by the Law Society of Alberta, ranging from reprimand and a fine, to suspension or disbarment. All details of the settlement with BMO are confidential, but CBC News reported that the Alberta Lawyers Insurance Association (“ALIA”), agreed to pay $9.2 million to settle the BMO claims on behalf of all 17 lawyers named in the suit.

Types of Mortgage Fraud There are several types of mortgage fraud schemes prevalent in the real estate market. Some of these are discussed below:

1. Value Fraud This is the most widely reported fraud and involves artificially overstated property values that are used to deceive mortgage lenders. Such frauds begin with the purchase of rundown houses in expensive neighborhoods. Fraudsters then collude with various parties to inflate either: (i) the original purchase price (e.g. where the vendor returns a portion of the purchase back after the sale), or (ii) the revenue potential of income-producing real estate. Either way results in overvalued mortgages. The fraudsters then find “straw” buyers, typically new immigrants often paid for, or deceived into, acting on behalf of the fraudsters for title transfer and mortgage application purposes. After the bank forwards the mortgage funds, the fraudsters complete the sale of the overpriced property to the straw buyer. When the straw buyer is unable to meet the mortgage payments, the bank forecloses. Since the properties are overvalued, the banks are unable to recover their mortgage debt from the subsequent foreclosure sales and thereby suffer significant losses. The straw buyers are left without homes and with tainted credit histories.

2. Private Mortgage Financing Fraud In these schemes, mortgage financing is realised by private offerings in which investors are promised high returns on real estate properties or projects. The fraudsters typically claim that high returns are possible because they have the ability to acquire, construct and sell real estate at substantial profit, or claim to have special access to acquire foreclosed properties at prices substantially below market value. Ultimately the actual transaction as outlined does not occur, or the private mortgage investors are left with mortgages on properties that will not cover the debt.

3. Mortgage Rescue Fraud These scams generally target vulnerable, low-income individuals whose homes are at risk of foreclosure. The fraudster approaches such owners with debt-consolidation schemes which involve the owner paying upfront fees and transferring the property title (sometimes unwittingly) to the fraudster. The legitimate owner typically receives a cash payout from the fraudster to address immediate bills and remains in the home paying “rent” or “consolidated debt payments” to the fraudster. The fraudster pockets all payments from the owner and ignores bills, taxes and mortgage payments which ultimate leads to debt-collection mortgage foreclosure procedures. The fraudster may also remortgage or sell the property to an accomplice, leaving the owner homeless and in debt.

4. Bankruptcy Mortgage Fraud A fraudster may acquire title to multiple properties with no intention of paying the mortgages. The perpetrator collects revenue from the properties, then files for bankruptcy to stall foreclosure and to allow the scheme to continue.

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5. Mortgage Fraud for Title This occurs when fraudsters use stolen or fake identification documents to change title. Using these documents they apply for and take out a mortgage on a property. The bank lends the money to the criminals based on the stolen or fake documents and leaves the victim with the debt.

Recourse for Victims Where Lawyers are Involved in the Fraud Where innocent parties suffer financial loss as a result of fraud or negligence by lawyers, the parties have several recourses available to them. If the loss was the result of fraud by a lawyer, such as misappropriation or wrongful use of trust money, then the affected client of that lawyer can make a claim against the Law Society of Alberta’s Assurance Fund. If the loss was a result of negligence by a lawyer acting on behalf of the victim, then such clients can make claims against the insurance carried by the lawyer as provided by ALIA. In addition, though not as a means of recovering any financial loss, victims of mortgage fraud, or anyone who witnesses a lawyer engaging in mortgage fraud, can file a complaint with the Law Society of Alberta. These recourses are discussed in the following sections.

The Assurance FundThe Legal Profession Act1 of Alberta requires the Law Society to maintain an assurance fund to compensate members of the public whose monies or property are misappropriated by a lawyer in the course of the lawyer’s practice. To fund this scheme, lawyers in Alberta are required to contribute to the “Assurance Fund”. The Law Society retains ultimate discretion as to whether any such claim should be paid. For a claim to be put forward against the Assurance Fund, the following elements must be present:

• The money or property must have been received by the lawyer concerned in his/her capacity as a lawyer and in the course of the lawyer’s practice;

• The lawyer concerned must have misappropriated or wrongfully converted such money or property;

• The claimant must be the person entitled to the money or property.

However, even if these statutory pre-conditions are met, the Law Society retains the discretion to refuse a claim. Factors which may lead to a refusal include significant delay in making the claim, refusal by a claimant to co-operate with the investigation and concerns regarding the good faith or conduct of the claimant that may have contributed to the loss.

If the claim is approved, the Assurance Fund will compensate only the money or value of property lost. There is no provision for claims for consequential losses such as interest, damages, expenses, loss of profits and loss of income.

Professional Liability Insurance Through ALIA, the Law Society of Alberta provides professional liability insurance and every Alberta lawyer in private practice must purchase a mandatory minimum level of insurance coverage. This insurance is to cover a client of that lawyer for losses arising from negligent practice.

Pursuant to the Supreme Court of Canada ruling in Canson Enterprises Ltd. v. Boughton & Co.2, where a solicitor breaches a contract of service through negligence, the injured client is entitled to be placed in the same position as if the solicitor had performed the contract in a careful manner.

Notifying ALIA of a claim does not stop or extend the deadline by which the complainant must start a lawsuit to keep the claim “alive” in context of the Alberta Limitations Act3. Depending on circumstances, the deadline may be as little as two years from when the lawyer performed the legal work. Alberta Courts have suggested that the following issues should be assessed in determining whether or not liability for an error or omission arises from the services rendered:

• What was the nature of the professional service performed?

• For what person or group of persons were the services performed?

• What acts, errors or omissions gave rise to a finding of negligence?

• Did the negligence cause the damages which are the subject of the claim?

A lawyer who acts in a capacity coincidental to the practice of law will not be covered for any error, unless the lawyer provides services normally within the scope of a solicitor-client relationship. Lawyers acting as executors, administrators, trustees, personal representatives, committees, guardians, and patent or trademark agents will be covered by their professional liability policy if it can be established that the services are in keeping with those usually provided by a lawyer. Other activities (such as investments or business enterprises) may not qualify. However, liability for legal services can extend beyond the solicitor-client relationship for negligent acts or omissions that cause foreseeable loss to third parties.

The Complaint ProcessFinally, victims of mortgage fraud, or anyone who witnesses a lawyer engaging in mortgage fraud, can access the process that the Law Society of Alberta provides for complaints regarding a lawyer’s ethical conduct. All members of the Law Society must adhere to the Law Society’s Code of Conduct. Breaches of the Code of Conduct may include knowingly assisting, or being wilfully blind to, a client perpetrating fraud. Although this process will not lead to financial compensation for victims, it is an important tool for holding lawyers accountable for unethical practice and deterring those who might contemplate engaging in mortgage fraud.

Once a complaint is initiated, the Complaints Manager determines whether or not the complaint should be dismissed or referred to the Conduct Committee. If the Conduct Committee determines that a lawyer acted improperly, it can conduct either a private mandatory conduct advisory, or a public hearing, depending on the seriousness of the misconduct. If the lawyer is found guilty at a hearing, penalties can be imposed including such penalties as reprimand, fine, suspension, disbarment and costs of the hearing.

Footnotes

1 RSA 200,c. L-82 [1991] 3 S.C.R. 5343 RSA 2000, c. L-12

Where innocent parties suffer financial loss as a result of fraud or negligence by lawyers, the parties have several recourses available to them.

IntroductionAs a general rule, liabilities arising out of statutory orders regarding employment, energy conservation or environmental matters relate to ongoing obligations owed to the public. Accordingly, they are not typically compromised when the party liable for such obligations becomes insolvent. However, the general rule no longer seems to apply in the context of environmental claims, given the recent Supreme Court of Canada (“SCC”) decision of Newfoundland and Labrador v. AbitibiBowater Inc.1, (“AbitibiBowater”). In that case, the SCC confirmed that a remediation order will be subject to insolvency proceedings, so long as monetary value can be attributed to the order.

BackgroundFor over 100 years, AbitibiBowater Inc. and its affiliated companies (“Abitibi”) were involved in industrial activity in Newfoundland and Labrador (the “Province”). In 2008, Abitibi became financially distressed and announced the closure of its last mill and the termination of its operation in the Province.

Within two weeks of the announcement, the Province passed the Abitibi-Consolidated Rights and Assets Act (the “Abitibi Act”), which resulted in the expropriation of all of Abitibi’s assets in the Province, without compensation.

In 2009, Abitibi filed for insolvency protection under the Companies’ Creditors Arrangement Act (“CCAA”) and filed a notice of intent to submit a claim to arbitration under NAFTA for approximately $300 million for losses resulting from the Abitibi Act.

Six months later, the Province issued five orders under the Environmental Protection Act, (the “EPA Orders”). The EPA Orders required Abitibi to submit and complete remediation action plans for five industrial sites, three of which had already been expropriated, over the course of only one year. In many instances, Abitibi had not even caused the contamination. The cost of remediation was estimated to be tens of millions of dollars.

That same day, the Province brought a motion for a declaration that the CCAA claims procedure order did not prevent the Province from enforcing the EPA Orders. The Province argued that the EPA Orders were not “claims” under the CCAA, and thus not subject to the CCAA stay of proceedings.

The IssueBoth the Quebec Superior Court and Court of Appeal held that the EPA Orders were “claims”, which could be compromised in a CCAA restructuring. When the Province appealed again, the SCC framed the question before it as follows:

when does a regulatory obligation imposed on a corporation pursuant to environmental protection legislation become a “claim” subject to CCAA proceedings?

The SCC DecisionThe SCC agreed with the lower courts’ reasoning and held that the EPA Orders could be caught by the restructuring process. In doing so, the SCC stated that a regulatory order could be a “claim” under the CCAA if it met the following three requirements:

• the order gives rise to a debt, liability or an obligation owed to a creditor;

• the debt, liability or obligation arises before insolvency proceedings are commenced; and

• the debt, liability or obligation has a “monetary value”.

Here, the SCC held that the first two requirements were met because the Province identified itself as a creditor by resorting to environmental protection enforcement mechanisms and the environmental damage occurred prior to the CCAA proceedings.

The question then became whether monetary value could be attributed to the EPA Orders, which had not been explicitly expressed in monetary terms.

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When May Remediation Orders be Compromised in a CCAA Restructuring?By: Carole Hunter, Simina Ionescu-Mocanu and Cassandra Calder

The SCC reminded the parties that the definition of a “claim” in the insolvency context is broad and includes contingent and future claims (meaning that the claims may be based on events that have yet to occur), so long as they are not too remote or speculative.

Applying this to the context at hand, an environmental order will be a “claim” if it is “sufficiently certain” that the regulatory body will ultimately perform the remediation work and assert a monetary claim to have its costs reimbursed.

In determining whether it is “sufficiently certain” that a regulatory authority would ultimately perform the remediation work, the SCC stated that the following factors should be considered:

• whether the activities causing the environmental damage are ongoing;

• whether the debtor is in control of the property;

• whether the debtor has the means to comply with the order;

• whether the regulatory body has specifically designated funds for remediation;

• whether the regulatory body has commenced remediation work; and

• the effect of compliance on the insolvency process.

Ultimately, the SCC found that it was “sufficiently certain” that the Province would eventually perform the remediation and assert a monetary claim against Abitibi because:

• Abitibi’s activities on the lands were not ongoing;

• Abitibi no longer controlled the properties; and

• Abitibi lacked funds and its operations were funded through debtor-in-possession financing, which limited access to ongoing operations.

Furthermore, the SCC suggested that the Province had acted in bad faith by unfairly targeting Abitibi. Abitibi was the only party subject to the EPA Orders, when others appeared responsible—in some cases primarily responsible—for the contamination.

Accordingly, three of the five remediation orders were characterized as monetary claims and thus compromised under the CCAA.

Future ImplicationsAbitibiBowater has very unique facts. It is therefore hard to predict what will constitute “sufficient certainty” in future cases.

It also remains to be seen whether, as a result of social and political pressures, Parliament will amend insolvency legislation to exempt environmental remediation orders from insolvency proceedings altogether.

We also wish to highlight that a debtor’s environmental obligations are not completely extinguished when remediation orders are characterized as “claims” for the purpose of a CCAA restructuring. Instead, the claims are secured by a charge on the contaminated property and the regulatory body benefits from a super-priority status under section 11.8(8) of the CCAA. In doing so, Parliament attempts to strike the right balance between the public’s interest in enforcing environmental legislation and the equal treatment of third party creditors.

In practice, however, the debtor company emerges from the restructuring without the legal obligation to remediate the contaminated property because: (i) the value of the security over the land itself is often negligible; and (ii) any clean-up costs claimed beyond the value of the land are unsecured and unlikely to be recovered.

Implementing AbitibiBowater in Alberta – a Different InterpretationThe impact in Alberta of AbitibiBowater will largely be seen in the restructuring of oil and gas producers holding various licences granted by the Alberta Energy Regulator (the “AER”).

Under the existing regime, no licensee (including a restructuring debtor) can transfer its AER licenses without the AER’s approval. Additionally, licensees that do not transfer all of their assets in one transaction may also be required to post a security deposit pursuant to the provisions of the licensee liability rating program (the “LLR Program”).

The purpose of the LLR Program, which is also administered by the AER, is to ensure that funds are available to suspend, abandon, remediate and reclaim a well, facility or pipeline in the event

that a licensee becomes defunct. Under the LLR Program, licensees are required to post a security deposit if the deemed asset value (based on reported production volumes) of their licensed assets is below their deemed liability value. The values are calculated each month and a licensee is given a specific period of time to post any required security deposit.

On a transfer of assets, the AER will calculate the deemed asset value to deemed viability value ratio of both the proposed purchaser and the transferee to determine whether either party must post a security deposit following the transfer. In most–if not all–cases involving a transfer by an insolvent transferee, a security deposit must be posted by the insolvent licensee, as the purchaser will have acquired the more desirable assets. The problem, of course, is that the insolvent transferee often does not have the funds necessary to post the security deposit required by the AER.

To make matters worse, the AER has been taking the position in recent CCAA restructurings that, in spite of AbitibiBowater: (i) the AER does not consider itself to be a creditor, (ii) the AER’s claim against a transferee for the unpaid security deposit is not a “monetary” claim, and (iii) the abandonment and reclamation of wells relates to public safety, as opposed to environmental concerns. This effectively sets the stage for the AER to argue that the security deposit required to transfer the licensees is not a claim that can be compromised in an insolvency proceeding.

Based on AbitibiBowater, the AER’s position seems untenable given: (i) the monetary nature of the AER’s claim for the security deposit, (ii) the fact that the security deposit is to be paid by the licensee to the AER, and (iii) the purpose of collecting the funds under the LLR Program, which is to cover the cost of abandonment and reclamation of wells, facilities and pipelines.

As courts in Alberta have yet to consider the AER’s perspective in light of AbitibiBowater, it is unclear whether its position would succeed in a court proceeding. For the time being, prospective purchasers may have to pay a premium to cover the insolvent transferee’s AER security deposit. In cases where purchasers are unwilling or unable to cover the costs, we are likely to see an increase in failed CCAA restructurings regarding licensees. Unfortunately, until a case on point is brought before the courts and a decision is rendered on the issue, the future outcome for Alberta oil and gas producers on this issue is less than certain.

Footnotes

1 2012 SCC 67

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Alberta Court Won’t Allow Lenders to Have Their Cake and Eat It Too:Warnings from a Recent Foreclosure CaseBy Simina Ionescu-Mocanu and Alison Koper

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Alberta Court Won’t Allow Lenders to Have Their Cake and Eat It Too:Warnings from a Recent Foreclosure CaseBy Simina Ionescu-Mocanu and Alison Koper

BackgroundIn a realization scenario, following a default by a borrower, a lender holding security over land (i.e. a mortgagee) has the right to purchase that land in exchange for its debt. In practice, this is often done in one of two ways: (i) the lender may successfully bid for the property after the court has granted an order nisi/ order for sale (which offers up the mortgaged property for sale to the public); or (ii) the lender may obtain a court order allowing the property to be sold directly to it at fair market value.

The latter (commonly referred to as a “Rice Order”), is a popular practice in cases where there is no equity in the lands and there are no encumbrances ranking ahead of the foreclosing mortgagee’s security.

Rice Order Can Lead to Unforeseen ConsequencesHowever, purchasing property through a Rice Order may create some unforeseen consequences when the lender is a second mortgagee or when the lands are subject to a number of encumbrances that rank in priority to the lender’s mortgage. This is exactly what happened to The Toronto-Dominion Bank (“TD”) in Servus Credit Union Ltd. v Miller [Servus].1

In Servus, TD had granted a line of credit to Mr. Miller and secured its indebtedness by a collateral mortgage against Mr. Miller’s property in the Village of Wabamun (the “Property”). The TD mortgage ranked behind a first mortgage granted by Mr. Miller in favour of Servus Credit Union Ltd. (“Servus”). The Servus mortgage was a high-ratio mortgage, which meant that Mr. Miller was liable for any deficiency owing to Servus, if Servus ever chose to realize on the Property.

When Mr. Miller defaulted on the TD line of credit, TD applied for and was granted a Rice Order, which granted TD title to the Property, subject to the Servus mortgage. At the time, TD was not concerned about its possible exposure under the Servus mortgage because the difference between the appraised fair market value of the Property relative to the outstanding amount of Servus’ indebtedness (i.e. the deficiency) was very low (only $6,398.93). In fact, we suspect that TD hoped that the Property value would increase over time, which would have allowed it to recover some of its lost indebtedness under the line of credit, without worrying about Servus’ outstanding first mortgage.

Unfortunately for TD, the value of the Property declined substantially after it obtained title to the Property. Although TD attempted to re-sell the Property for its prior appraised value ($128,000), it could not find any interested buyers.

To make matters worse, after the failed re-sale, Servus also decided to realize on the Property by obtaining its own Rice Order. This time, the Property’s appraised fair market value was $75,000, which entitled Servus to pursue TD (the current owner of the Property) for the $39,288.97 deficiency, plus costs. Servus took advantage of its rights and sued TD for the deficiency. TD applied to dismiss Servus’ application, but was unsuccessful.

After looking at the applicable provisions of the Alberta Land Titles Act2 and prior case law, the Court reiterated the general legal principle that a Rice Order does not extinguish the underlying debt owing with respect to the lands.3 TD therefore remained responsible for Servus’ first mortgage (and the obligation to pay the $39,288.97 deficiency associated with it).

The Court contrasted the Rice Order process with a purchase of land in a court-ordered tender or sale process, where the property passes to the purchaser “free and clear of prior encumbrances”. As far as a second mortgagee may be concerned, the distinction may appear minor in practice, since the proceeds from any court-ordered sale are paid to the creditors who have security over the lands based on the priority of their relative charges. However, getting title to property through a Rice Order can be a much more dangerous process when (as was the case in Servus) the prior encumbrances contain covenants that expose the owner of the lands to additional liability.

By purchasing the Property in Servus, TD not only relinquished its rights against Mr. Miller in respect of his indebtedness under the TD line of credit, but also incurred additional liability to Servus for its deficiency, which increased substantially when the Property value dropped. Had TD chosen to apply for an order nisi/ order for sale (instead of the Rice Order), the Property would have been sold to TD (or another purchaser that may have out-bid TD in the tender process), free and clear of prior encumbrances. In that case, the sale proceeds would have been used to pay out senior encumbrancers’ debt (including Servus’ first mortgage) and TD would have, at most, lost its right to pursue Mr. Miller for the debt outstanding under the line of credit. However, TD would not have become liable for Servus’ deficiency.

Moral of the StoryThe moral of this story is that lenders purchasing encumbered land through a Rice Order cannot “have their cake and eat it too”! Lenders should therefore ensure that they have fully evaluated the risks and considered the value of the encumbrances registered on title before purchasing property through a Rice Order. In cases where the value of the lands is uncertain, lenders may stand to lose not only the value of their debt, but also be on the hook for additional indebtedness arising under prior encumbrances.

Footnotes

1 Servus Credit Union Ltd. v Miller, 2012 ABQB 765.2 Land Titles Act, R.S.A. 2000, c. L-4.3 This principle is based on the notion that the lender purchasing the property through a Rice Order is, in effect, given a “credit” for the value of the debt owing with respect to the land (including the

value of the debt owing to prior encumbrancers on title). This, in turn, justifies requiring that lender to indemnify the prior encumbrancer for any outstanding amount under its encumbrance based on the public policy principle that it would be unfair to credit a purchasing lender for the value of a prior encumbrance while, at the same time, relieving it from liability under that encumbrance.

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