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SCC addresses third-party litigation funding, key issues in Companies’ Creditors Arrangement Act

Wednesday, May 13, 2020 @ 11:56 AM | By Cristin Schmitz

The Supreme Court of Canada has spoken for the first time on the legality of third-party litigation funding agreements, in unanimous reasons for judgment that also shed new light on many aspects of the Companies’ Creditors Arrangement Act (CCAA) — the federal statute which enables the reorganization of insolvent debtor companies facing claims in excess of $5 million.

The May 8 joint reasons for judgment of Supreme Court Chief Justice Richard Wagner and Justice Michael Moldaver build on the top court’s first CCAA ruling in Century Services Inc. v. Canada (A.G.) 2010 SCC 60, including by: clarifying the nature and scope of the “broad but not boundless” judicial discretion in CCAA proceedings, as well as the “highly deferential” standard of appellate review applicable to decisions of supervising judges; and elucidating overarching principles, objectives and key terms that apply in the context of what the court describes as the “evolving nature” of CCAA proceedings: 9354-9186 Québec inc. v. Callidus Capital Corp. 2020 SCC 10.

The 70-page reasons for judgment, which came in a Quebec appeal that was allowed 7-0 from the bench Jan. 23, rule on two main issues, and conclude that a supervising judge has (1) the authority under s. 11.2 of the CCAA to approve third-party litigation funding as “interim financing” and (2) the authority and discretion under s. 11 of the CCAA to bar from voting on a proposed plan of arrangement a creditor who is acting for an “improper purpose.”

The court addresses many other noteworthy points in its reasons including: affirming that third-party litigation funding agreements (LFAs) are not per se illegal; the meaning of “interim financing” and “plans of arrangements” in CCAA proceedings; elaborating on the nature of the “due diligence” called for in insolvency proceedings; and specifying the multiple remedial objectives of the CCAA, and three “baseline considerations” that a supervising judge must keep in mind when exercising discretion pursuant to s. 11 — the CCAA provision that empowers the court to make any order it considers “appropriate in the circumstances.”

Jeremy Opolsky, Torys

Jeremy Opolsky, a commercial and insolvency litigator with Torys in Toronto, said one takeaway from the court’s discussion of litigation funding is its affirmation that LFAs can advance the CCAA’s objective to realize the value of a debtor company’s assets, especially when, as in the Callidus case, the debtor only has a single asset — a damages claim. “The other [takeaway] is that the Supreme Court of Canada proceeded ... cautiously with respect to litigation funding, but it did confirm that litigation funding is not per se illegal, and the implication is that litigation funding is here to stay,” Opolsky observed.

In the wake of Callidus, he predicted LFAs will be used more often in the insolvency context, where they can act as a vehicle for access to justice for a debtor company’s claims that it could not otherwise afford to pursue.

Kevin McElcheran, author of Commercial Insolvency in Canada, a book cited by the Supreme Court, said the Callidus reasons for judgment are a must-read for bankruptcy and insolvency practitioners.

“The decision is well written and clear,” he said. “It takes another step on the path set by the Century Services case, where the court looked at Canada’s restructuring statutes as creating a comprehensive structure for formulating appropriate responses to commercial insolvency, and supporting the role of the supervising judge to guide the parties through to practical and fair going-concern solutions,” McElcheran remarked. “Because the court endorses the exercise of judicial discretion, it does not set rules, but sets standards which judges will have to interpret on a case-by-case basis,” he noted. “I think the judges will expect creditors with positions of influence in insolvency processes to bring forward their issues and concerns, and to actively participate in the process.”

Kevin McElcheran, lawyer

Janis Sarra, a professor at the University of British Columbia’s Peter Allard School of Law who was extensively quoted by the judges, told The Lawyer’s Daily the court “has reinforced the deference that appellate courts should give to decisions of the supervising judge in proceedings pursuant to the CCAA.”

“What is novel in Callidus is the Supreme Court’s clear direction that the supervising judge has the authority to bar a creditor from voting where it concludes that the creditor is trying to undermine the objectives of the CCAA,” Sarra said. The court “affirmed that the CCAA is aimed at: timely, efficient and impartial resolution of a debtor company’s insolvency; preserving and maximizing value of the company; ensuring fair and equitable treatment of claims; preserving jobs and communities where possible; protecting the public interest; and balancing the costs and benefits of restructuring or liquidation,” she elaborated. “The Supreme Court found that the [supervising] judge’s decision to bar the creditor from voting — because it was trying to circumvent the creditor democracy that the CCAA aims to protect — should be accorded a high level of deference.”

The court’s second novel determination is that litigation funding is permissible as an interim financing strategy in a CCAA proceeding “where it is fair and appropriate in all the circumstances,” and that it is not necessarily a “plan” under the CCAA such that a creditor vote is necessary, Sarra said.

McElcheran said the Callidus ruling is also important for the court’s commentary on the flexibility of the CCAA to support creative solutions, on a case-by-case basis, to the problems presented by commercial insolvency.

The “decision as a whole is an endorsement of judicial discretion as a powerful resource in the restructuring process,” he explained. “It encourages supervising courts and the parties involved in restructuring proceedings to use the flexibility of the CCAA to solve real life problems as they arise in CCAA cases. For example, the court endorses the use of the CCAA to sell businesses to achieve going-concern solutions, preserving employment and other ongoing relationships of the business, even when a plan of arrangement may not be possible. Similarly, the court recognizes the transformative effect of ‘interim’ orders, such as interim financing to support litigation. The court can approve such steps — the sale of a business to a new, solvent owner or the financing of litigation to create a ‘pot of gold’ for later distribution — without a plan of arrangement.”

Doug Fenton, Bennett Jones

Doug Fenton of Bennett Jones in Toronto, whose article on litigation funding agreements, co-written with Ranjan Agarwal, was referred to by the Supreme Court, noted that Callidus marks the court’s first commentary on LFAs.

“The issues before the Supreme Court were fairly narrow,” he noted. “The Supreme Court expressly stated that it was not opining on the contours or legality of litigation funding agreements generally, including in the class actions context, where the majority of judicial attention has been to date.”

Nevertheless the court did affirm for the first time that LFAs are not per se illegal as champertous, a conclusion also reached by a number of lower courts. “With that endorsement, I expect we will continue to see a proliferation of LFAs in a variety of contexts — for example, in insolvency proceedings, class action proceedings, and, increasingly, commercial litigation,” Fenton predicted.

He added, “the Supreme Court also appears to have tacitly endorsed the standard developed by lower courts for the approval of LFAs, outside the insolvency context. While the Supreme Court was focused on the approval of an LFA under s. 11.2 of the CCAA, it cited with approval cases dealing with the approval of LFAs in the class actions context. In those cases, courts have focused on whether the agreement is ‘fair and reasonable’ having regard to, among other things, the financial risk assumed by the litigation funder, the terms of the payout on success, and the extent to which the client/lawyer remain able to direct the litigation.”

Fenton noted it remains an open question whether judicial approval of LFAs is necessary in all circumstances and contexts. “The logic of having LFAs approved in insolvency proceedings and class actions is clear, as the litigation is being conducted in a representative capacity,” he remarked. “Court approval is necessary to protect the interests of the interested parties not directly participating in the litigation, that is class members or creditors.”

But he suggested the same fairness concerns may not arise where LFAs are executed by a sophisticated litigant in “ordinary” commercial litigation. “My own view is that there is no real principled reason to require court approval in ordinary commercial litigation,” Fenton said. “It appears that the case law in lower courts is beginning to evolve in that direction. However, that issue will have to await another day for express determination by the Supreme Court.”

The Supreme Court’s reasons in Callidus explain why it allowed the appeals, in the context of ongoing CCAA proceedings, of two debtor numbered companies in Quebec, whose assets almost all have been liquidated. The business, operating under the name Bluberi, manufactured, sold and serviced electronic casino gaming machines. Bluberi sought an initial order for CCAA protection in 2015, following the ballooning of its debts and financial troubles over the previous three years after it borrowed $24 million from a distressed lender, the respondent Callidus, and ran up millions in interest and other charges, secured in part by a share pledge agreement.

The appellant plans to file a lawsuit for some $200 million in damages against Callidus, which eventually took over Bluberi’s ownership when the latter could not meet its financial commitments. Bluberi alleges its liquidity problems stemmed from the respondent taking de facto control of the company and dictating a number of intentionally detrimental business decisions, with a view to depleting Bluberi’s equity value, gaining control of the ongoing business and, ultimately, selling it.

Chief Justice Richard Wagner

The Supreme Court of Canada restored the decisions of the supervising judge below which (1) authorized a $20-million third-party LFA as interim financing; and (2) restored the supervising judge’s decision to bar Callidus from voting on a second plan of arrangement (nearly identical to the first plan Callidus proposed that was voted down earlier by other creditors) due to Callidus’s “improper purpose” of trying to manipulate the second vote to ensure its plan would succeed, despite the first plan having previously failed.

Chief Justice Wagner and Justice Moldaver held that the Quebec Court of Appeal failed to treat the supervising judge’s discretionary decisions with the high degree of deference required.

The CCAA is silent on when a creditor who is otherwise entitled to vote on a plan or compromise can be barred from voting, but the Supreme Court found the requisite jurisdiction in s. 11 of the Act. “Where a creditor is seeking to exercise its voting rights in a manner that frustrates, undermines or runs counter to the remedial objectives of the CCAA — that is acting for an improper purpose — s. 11 of the CCAA supplies the supervising judge with the discretion to bar that creditor from voting,” Chief Justice Wagner and Justice Moldaver held. “Whether this discretion ought to be exercised in a particular case is a circumstance-specific inquiry that the supervising judge is best-positioned to undertake.”

In this case the respondent secured creditor was appropriately barred from voting on the new plan because its actions were aimed at circumventing the creditor democracy the CCAA protects, the Supreme Court held.

In addition Callidus failed to act with the due diligence required in insolvency proceedings, including with respect to valuing its claims and security, the Supreme Court said. “Put simply, Callidus was seeking to take a ‘second kick at the can’ and manipulate the vote on the new plan,” Chief Justice Wagner and Justice Moldaver wrote. “The supervising judge made no error in exercising his discretion to prevent Callidus from doing so.”

“Discretionary decisions like this one must be approached form the appropriate posture of deference,” the pair emphasized. “It bears mentioning that, when he made this decision, the supervising judge was intimately familiar with Bluberi’s CCAA proceedings. He had presided over them for over two years, received 15 reports from the [court-appointed] monitor, and issued approximately 25 orders.”

Justice Michael Moldaver

In holding that the supervising judge also made no error in approving the LFA as interim financing pursuant to s. 11.2 of the CCAA, Chief Justice Wagner and Justice Moldaver noted that “interim financing” — a term not defined by the Act — may take on a range of forms.

“Third-party litigation funding may be one such form,” they stipulated. “Whether third-party litigation funding should be approved as interim financing is a case-specific inquiry that should have regard to the text of s. 11.2 and the remedial objectives of the CCAA more generally.”

The Supreme Court went on to rule that it was “apparent” that the supervising judge was focused on the fairness at stake to all parties, the specific objectives of the CCAA and the particular circumstances of this case when he approved the LFA as interim financing.

“We cannot say that he erred in the exercise of his discretion,” Chief Justice Wagner and Justice Moldaver wrote. “Although we are unsure whether the LFA was as favourable to Bluberi’s creditors as it might have been — to some extent, it does prioritize [litigation funder] Bentham’s recovery over theirs — we nonetheless defer to the supervising judge’s exercise of discretion.”

The Supreme Court noted that outside the CCAA context, the approval of third-party LFAs “has been somewhat controversial,” partly because of their potential to offend the common law doctrines of champerty and maintenance. However, building on jurisprudence holding that contingency fee agreements are not champertous when they are not motivated by an improper purpose, lower courts have increasingly come to recognize that litigation funding agreements are not per se champertous. “The jurisprudence on the approval of third-party LFAs in the class action context — and indeed, the parameters of their legality generally — is still evolving, and no party before this court has invited us to evaluate it,” Chief Justice Wagner and Justice Moldaver commented. “That said, insofar as third-party LFAs are not per se illegal, there is no principled basis upon which to restrict supervising judges from approving such agreements as interim financing in appropriate cases. We acknowledge that this funding differs from more common forms of interim financing that are simply designed to help the debtor ‘keep the lights on’. However, in circumstances like the case at bar, where there is a single litigation asset that could be monetized for the benefit of creditors, the objective of maximizing creditor recovery has taken centre stage. In those circumstances, litigation funding furthers the basic purpose of interim financing allowing the debtor to realize on the value of its assets.”

Chief Justice Wagner and Justice Moldaver concluded that third-party litigation funding agreements may be approved as interim financing in CCAA proceedings when the supervising judge “determines that doing so would be fair and appropriate, having regard to all the circumstances and objectives of the Act. This requires consideration of the specific factors set out in s. 11.2(4) of the CCAA. That said, these factors need not be mechanically applied or individually reviewed by the supervising judge. Indeed, not all of them will be significant in every case, nor are they exhaustive. Further guidance may be drawn from other areas in which third-party litigation funding agreements have been approved.”

The Supreme Court rejected the arguments of Callidus and the other respondent creditors that the litigation funding was not interim financing under the CCAA, but rather a “plan of arrangement” (a term not defined by the statute) which, as such, had to be put to a creditors’ vote under ss. 4 and 5 of the CCAA before it received court approval (or at least the LFA should have been accompanied by a plan of arrangement. )

Setting out an exhaustive definition of plan of arrangement or compromise was unnecessary to resolve the appeals at bar, Chief Justice Wagner and Justice Moldaver said. They noted, however, that “third-party LFAs are not necessarily, or even generally, plans of arrangement.”

“For our purposes, it is sufficient to conclude that plans of arrangement require at least some compromise of creditors’ rights,” they explained. “It follows that a third-party LFA aimed at extending financing to a debtor company to realize on the value of a litigation asset does not necessarily constitute a plan of arrangement,” they reasoned. “We would leave it to supervising judges to determine whether, in the particular circumstances of the case before them, a particular third-party LFA 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 pair added, however, that there may be circumstances in which a third-party LFA may contain or incorporate a plan of arrangement (for example, if it contemplates a plan for distribution of litigation proceeds among creditors).

Alternatively, they said a supervising judge may determine that, despite an LFA itself not being a plan of arrangement, it should be packaged with a plan and submitted to a creditors’ vote.

The Supreme Court agreed with the supervising judge that the LFA is not a plan of arrangement because it does not propose any compromise of the creditors’ rights. “We accept that this charge would have the effect of placing secured creditors like Callidus behind in priority to Bentham. However this result is expressly provided for in s. 11.2 of the CCAA,” they said. “This ‘subordination’ does not convert statutorily authorized interim financing into a plan of arrangement.”

Interim financing, a CCAA term that is not defined in the statute, has been described by commentators as referring primarily to the working capital a debtor company requires in order to keep operating during restructuring proceedings, as well as to the financing needed for paying the cost of the workout process.

“That said, interim financing is not limited to providing debtor companies with immediate operating capital,” Chief Justice Wagner and Justice Moldaver stipulated. “Consistent with the remedial objectives of the CCAA, interim financing at its core enables the preservation and realization of the value of a debtor’s assets.”

In the three years after Callidus extended a credit facility of about $24 million to Bluberi, the latter lost a lot of money, while continuing to borrow. By 2015, the company owed Callidus about $86 million — close to half of which Bluberi claims is made up of interest and fees.

The supervising Quebec Superior Court judge issued an initial order under the CCAA in 2015, confirming, among other things, that: Bluberi was a “debtor company” within the meaning of s. 2(1) of the Act; staying any proceedings against Bluberi or any of its directors or officers; and appointing Ernst and Young Inc. as a monitor under the CCAA.

Bluberi and the monitor determined that the company had to sell its assets. On Jan 28, 2016, Bluberi proposed a sale solicitation process, which the supervising judge approved. As a result Callidus agreed to obtain all of Bluberi’s assets, in exchange for extinguishing all but $3 million of its secured claim against Bluberi, which secured claim had by then had grown to about $136 million. The agreement also permitted Bluberi to retain its claims for damages against Callidus arising from the latter’s alleged involvement in Bluberi’s financial problems — a claim Bluberi asserted should amount to more than $200 million in damages.

The supervising judge approved the asset purchase agreement and the sale of Bluberi’s assets to Callidus — which closed in February 2017. Callidus thus effectively acquired Bluberi’s business and continued to operate it as a going concern. Since the sale, the retained damages claims were Bluberi’s sole remaining asset, and thus the only security for Callidus’s $3-million claim.

On Feb. 6, 2018, Bluberi filed one of the applications underlying the appeals to the Supreme Court, seeking authorization of a proposed third-party LFA with a publicly traded litigation funder, IMF Bentham Ltd or its Canadian subsidiary, Bentham IMF Capital Ltd. Bluberi’s application also sought to place a $20-million super-priority charge in favour of Bentham on Bluberi’s assets. The LFA provided that Bentham would fund Bluberi’s litigation of its retained claims in exchange for receiving part of any settlement, or award after trial. If the litigation failed, Bentham would lose all of its invested funds. The agreement also stipulated that Bentham could terminate the litigation of the retained claims, if acting reasonably, it was no longer satisfied of their merits, or the commercial viability of litigation.

Callidus contested Bluberi’s application on the ground that the LFA amounted to a “plan of arrangement” and, as such, had to be submitted to approval by a creditors’ vote.

The supervising judge disagreed that the LFA was a plan of arrangement — defining the latter as involving “an arrangement or compromise between a debtor and its creditors”. He authorized Bluberi to enter an LFA with Bentham as proposed (and as supported by the monitor) and imposed the LFA financing charge on Bluberi’s assets.

The supervising judge also rejected an application to put a second plan of arrangement to a creditors’ vote — a plan which was almost the same as the first plan that Callidus put forward which had been rejected by a creditors’ vote (the second plan upped a proposed distribution to creditors to $2.9 million from $2.6 million).

While creditors are generally entitled to vote in their own self-interest, the supervising judge concluded that Callidus had an improper purpose of attempting to override the result of the first vote, and to obtain releases from the anticipated litigation. He barred Callidus from voting. Because Callidus was not permitted to vote on the new plan, and another creditor had stated it would vote against it, the supervising judge concluded the plan had no reasonable prospect of success and declined to submit it to a vote.

Relying heavily on the notion that creditors have a right to vote in their own self-interest, the Quebec Court of Appeal reversed on both issues. It held that Callidus’ conduct before and during the CCAA proceedings, and its transparent attempt to obtain a release from Bluberi’s claims, did not amount to an improper purpose.

Moreover, the Court of Appeal held that the supervising judge erred in approving the LFA as interim financing because, in its view, the LFA was not connected to Bluberi’s commercial operations. The Appeal Court held the supervising judge misconstrued in law the notion of interim financing and misapplied it to the circumstances.

Photo of Chief Justice Richard Wagner by Supreme Court of Canada Collection
Photo of Justice Michael Moldaver by Jessica Deeks

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