In the April 2022 decision of Harte Gold Corp. (Re), the Ontario Superior Court of Justice [Commercial List] (the Court) provides guidance on the appropriate use of reverse vesting orders (RVOs) in insolvency proceedings and enumerates key questions that must be addressed prior to the granting of an RVO. It is clear that the Court's reasoning in Harte Gold will have far reaching implications. For example, in the July 2022 decision of BlackRock Metals (Re), the first reported decision in a contested RVO case following Harte Gold, the Superior Court of Quebec [Commercial Division] cited the case at length and applied Harte Gold's reasoning in granting the RVO over the objection of a group of shareholders.
This bulletin considers the questions raised in Harte Gold and the implications they have for monitors, debtors, purchasers and other stakeholders in a Companies’ Creditors Arrangement Act (CCAA) sale process seeking to consummate a transaction pursuant to an RVO.
In short, an RVO allows for the transfer of liabilities or unwanted assets out of the debtor company into a newly formed entity (ResidualCo) or existing subsidiary, prior to transfer of the shares of the existing debtor company, cleansed of unwanted liabilities, to a purchaser. It is the “reverse” of a conventional vesting order because the purchased assets stay in the debtor entity, and the liabilities and excluded assets are vested out. RVOs have been increasingly used in Canada in recent years to facilitate restructurings in situations where the debtor company possesses valuable attributes, such as governmental licenses and permits or tax losses, which would be difficult or impossible to transfer in an asset sale. For this reason, RVOs have been used with increasing frequency in the cannabis and mining spaces and other heavily regulated industries.
The increased use of RVOs, however, has met with some scrutiny because it essentially provides the same commercial and economic benefits for the debtor and purchasers as can be achieved through a CCAA plan (i.e., generating sale value, and cleansing a debtor company of unwanted liabilities so that the CCAA debtor can emerge from creditor protection as a viable going concern under new ownership). It, however, does so without the requirement for approval by each class of affected creditors in the requisite majorities (a numerical majority of voting creditors representing two-thirds of voting claims, in each affected class). Pursuant to an RVO, out-of-the-money unsecured creditors may have their claims stranded in ResidualCo. In a CCAA plan, however, they would have to receive some consideration in order to secure their vote. As a result, even though courts and practitioners across Canada continue to view RVOs as important value-maximizing instruments, some commentators have suggested the use of RVOs undermines the foundational principle of creditor democracy.
In the recent uncontested motion for an RVO in Harte Gold, involving the sale of a gold mine in Northern Ontario via a credit bid, the Court granted the RVO and sought to reconcile these competing views and provide guidance to restructuring practitioners in assessing when the use of RVOs is appropriate. The Court directed the debtor, the purchaser and especially the court-appointed monitor, which serves as the independent “eyes and ears” of the court, to consider the following questions:
Why is the RVO necessary in this case?
Does the RVO structure produce an economic result at least as favourable as any other viable alternative?
Is any stakeholder worse off under the RVO structure than they would have been under any other viable alternative?
Does the consideration being paid for the debtor’s business reflect the importance and value of the licenses and permits (or other intangible assets) being preserved under the RVO structure?
The questions are not entirely discrete and separate but intertwined and overlapping. With that in mind, the implications of each of these questions are considered below.
1. What’s necessary? The Court must be satisfied that an RVO is “necessary”. Where there are unassignable licences or permits that are critical for the efficient operation of the business by a prospective purchaser, the necessity seems clear. Similarly, where conveying permits and licences to a purchaser that are technically assignable, but where assignment involves delay, cost or risk, to the detriment of stakeholders, as was the case in Harte Gold, the RVO structure is well suited to bridge the gap. But when does “necessary” slip in to “convenient” or “efficient”, and what mischief ought courts to be on the lookout for when that slippage may happen? Further, are there circumstances where the purchaser itself will seek to manufacture necessity?
For example, a purchaser may require a third-party release or an assignment of a contract as a condition to closing a transaction. The purchaser may also designate an outside date by which the transaction must close. These purchaser-dictated criteria are often used as a basis to seek required or “necessary” relief from a court, including on an expedited basis, and purchaser-dictated expediency is sometimes the subject of a court’s scrutiny. If it is possible to consummate a transaction without an RVO, but the purchaser is only prepared to do so pursuant to an RVO, does that purchaser entrenchment, in and of itself, constitute necessity? The purchaser may very well have legitimate concerns about cost and transaction risk, but at what point does the expediency, administrative simplicity, cost effectiveness or tax efficiency that usually arises from an RVO become a convenience, as opposed to a necessity? Also, as discussed below, there may be a lower offer by a party, with a monetarily inferior bid, that is willing to proceed by way of a CCAA plan or traditional vesting order. The existence of such a bid would suggest that the RVO is not strictly necessary, although an RVO may be required to optimize recovery.
It would be counterintuitive, however, to compel a debtor to accept an inferior offer in these circumstances, nor would creditors want such a lower recovery. What constitutes “necessary” will be highly case specific and should be understood in the context of the value-maximizing goals of the CCAA.
2. How do we measure economic results, on a relative basis? On its face, this question posed by the Court seems clear, asking in essence: does the RVO result in a purchase price as high as any other offer?
There are scenarios, however, where a more nuanced analysis may be required. Following on the point above regarding competing bids, assume Purchaser A offers to pay C$10-million for certain assets of a debtor, to be facilitated through a conventional vesting order. Purchaser A is taking into account the risk that certain permits or licences may be unassignable, or the assignment may be costly or delayed, and prices this into its bid. Purchaser B offers to pay C$10.5-million for the same assets of the debtor that Purchaser A has bid on but requires that the transaction be facilitated through an RVO and share transfer. At first blush, the answer to the question “does the RVO structure produce an economic result as least as favourable to any other viable alternative” would appear to be “yes”.
Purchaser B, however, is avoiding the risks, costs and delays of transferring licences and permits. Purchaser B is ostensibly paying an extra C$500,000, but it is receiving significant benefits with respect to time, efficiency, certainty. Would Purchaser A be willing to pay more than Purchaser B for the same advantages? In order to do an “apples to apples” comparison, is it incumbent on the debtor and/or monitor to invite Purchaser A to resubmit its offer by way of a share purchase acquisition to be approved by way of an RVO?
If the debtor and monitor are of the view that an RVO is “necessary” in the circumstances to maximize value for stakeholders, it would appear prudent to ensure that all participants in a bidding process have an equal opportunity to submit their offer using an RVO structure to ensure that maximum economic result can be achieved and there is an opportunity to compare “like” bids. Of course, the debtor and monitor cannot presume that a court will approve an RVO structure.
3. Is anyone worse off? The Court must consider whether any stakeholder is “worse off under the RVO structure than they would have been under any other viable alternative”. Notably, the purchaser in Harte Gold agreed to pay the cure costs (i.e., pre-filing monetary arrears) of retained contracts. Although when using a traditional vesting order cure costs have to be paid when assigning contracts, arguably these liabilities could have been assigned to and stranded in ResidualCo. The Court took comfort in this case that Harte Gold did not seek to test this proposition and paid cure costs, as it helped establish that contractual counterparties were not being prejudiced by the RVO structure, relative to a traditional vesting order structure. Moreover, the RVO in Harte Gold did not purport to move environmental liabilities to ResidualCo. These liabilities continued, as they would have in a traditional asset sale.
In Harte Gold these pragmatic decisions were able to provide additional comfort to the Court that no particular stakeholder was prejudiced by the RVO structure. However, when canvassing the universe of alternatives available to a debtor, there is a great deal of “grey area” in determining if a particular stakeholder is “worse off”. Various scenarios are considered below:
Plan. In order to get a plan approved that compromises unsecured claims, in addition to ultimate court approval, the debtor will need to secure the support of a sufficient number of unsecured creditors to meet the double majority voting threshold. Accordingly, plans of this nature provide for some consideration (money, equity, etc.) to go to unsecured creditors to compromise their claims. This value directly or indirectly comes at the expense of any secured creditors or, if secured creditors are being paid in full, the plan sponsor. All other things being equal, a plan will often be the best possible result for unsecured creditors.
Conventional asset sale and vesting order. In a conventional asset sale, the successful purchaser takes only those assets it wants, leaving behind the liabilities it does not want. The net purchase price is then typically applied against priority claims and then paid to the ranking secured creditors. Unsecured creditors would not receive any distribution if the secured creditor is underwater. All other things being equal, a conventional asset sale is preferrable to secured creditors, than a plan, as there is no requirement to compensate out-of-the-money unsecured creditors. In addition, the cost of calling and conducting a meeting of creditors can be avoided.
RVO. In an RVO, the purchaser could seek to have all claims assigned to ResidualCo. Proceeds of sale (unless it is a credit bid) will typically be paid into ResidualCo as well. The structure is set up to replicate the economic result achieved for creditors in an asset sale with a conventional vesting order. Accordingly, the RVO structure is often optimal for purchasers, but, like a traditional asset sale with a vesting order, often inferior to a plan for unsecured creditors.
So, who is worse off under an RVO structure relative to any viable alternative? In a plan, generally speaking, value that would accrue to the benefit of compromised secured creditors “leaks” out to unsecured creditors to solicit their vote, even if unsecured creditors are out of the money. The unsecured creditors thereby have some leverage in the negotiation of a plan. However, a conventional asset sale and vesting order may yield no such unsecured recovery. If an RVO is ”necessary”, a court must have concluded that a traditional asset sale would be a worse result.
Questions number two and three posed in the Harte Gold decision require a comparison of “viable alternatives”. The Court, however, does not articulate how viability should be assessed. In considering the viability of alternatives, it would seem necessary to consider the positions of stakeholders, including the purchaser, any secured creditor whose claim would be compromised in a plan, the proposed plan sponsor, applicable regulators, any licensors, any DIP lender, unsecured creditors, a pension administrator, etc. But to what extent does stakeholder opposition to RVO alternatives inform the viability of those alternatives? In Quest University, for example, the stakeholder who unsuccessfully opposed the RVO purported to hold a sufficiently large claim that it could have caused a plan to fail a creditor vote. However, the validity of the objecting creditor’s claim and accompanying veto rights was circumspect. As Justice Penny explicitly notes in the Harte Gold decision, the bona fides, motivations and objectives of the objector in Quest University were found to be “suspect and inadequate”. Further, although the concept of “viability” is not referenced, Justice Fitzpatrick carefully considers in the Quest University reasons the universe of alternatives to an RVO, and concludes, in granting the RVO, that it was “the best option available.”
Assessing viability of alternatives, and the reasonableness of parties opposing one of these alternatives, may be an area where monitors are called upon to play a particularly active role. Monitors may need to lay out a careful consideration of alternatives, the obstacles that stand in the way of pursuing those alternatives and if it is reasonable to believe those obstacles could be circumvented.
4. When is someone getting something for nothing? Harte Gold’s fourth question requires that the Court scrutinize whether the consideration being paid for the debtor’s business reflects the importance and value of the licenses and permits (or other intangible assets) being preserved under the RVO structure. In other words, a court must be satisfied that a purchaser is not getting something from the granting of an RVO for nothing.
The Court in Harte Gold seems particularly concerned in the context of a credit bid, as the purchaser’s security does not typically encompass non-transferable licenses and permits. If the successful credit bidder participated in a competitive bidding process and its bid was ultimately the highest and best, it would appear that fact, in and of itself, means that appropriate consideration has been provided for the benefit of the licenses and permits (assuming, that all parties at least had the opportunity to frame their bid as an RVO transaction as well).
Consider a situation, though, where as part of a competitive process, bidders are provided with a template asset purchase agreement. At a later date, as has been the case in certain transactions where RVOs were granted, the bidder opts to reconstitute its bid as a share purchase transaction instead of an asset purchase transaction. This may be done, for example, to facilitate a closing where conditions for the assignment of permits and licences cannot be met. Provided the conditions to closing could have been satisfied under the original asset purchase agreement, however, it would appear at least in these circumstances, some additional consideration may need to be offered by the successful purchaser to reflect the additional benefit accruing to it and the cost borne by the estate to restructure the previously agreed to transaction. Purchasers, concerned with being asked to pay a premium at a later date, may wish to expressly condition any offer they make on the basis that they can elect to revise their offer as an RVO transaction and make it clear the purchase price being offered constitutes consideration for this option.
In framing a CCAA sale process, debtors and monitors may have to consider whether, when and how to introduce the RVO as a potential structure, or how to include it from the outset, recognizing that the court will determine “necessity” and “fairness” on final approval. In framing a fair sale process, debtors/monitors need to consider whether an RVO should be presented as an option from the outset or whether the process should play out in the traditional manner, unless and until necessity dictates an alternative approach.
Undoubtedly, debtors, purchasers, creditors, monitors and their counsel will find ways to address the Harte Gold RVO considerations. We have already seen the Harte Gold analysis be applied by the Superior Court of Quebec (Commercial Division) in BlackRock Metals (Re), with a particular focus on what was fair and reasonable in the context of that particular case. Every case will require its own case-specific questions and answers. What remains to be seen is what answers will satisfy the courts.
For more information, please contact:
Pamela L. J. Huff +1-416-863-2958
Linc Rogers +1-416-863-4168
Chris Burr +1-416-863-3261
or any other member of our Restructuring & Insolvency group.
The authors would like to thank Caitlin McIntyre and Alexia Parente, Associates in the Restructuring & Insolvency group of the Blakes Toronto office, for their contributions to this article.