When an insolvent company contemplates filing for creditor protection under one of Canada’s principle restructuring statutes, it may require interim financing or, as more typically referred to in the U.S., debtor-in-possession (DIP) financing. The availability of, and allowance for, DIP financing in Canada under the proposal provisions of the Bankruptcy & Insolvency Act1 and the Companies’ Creditors Arrangement Act2 (CCAA) are intended to reflect their statutory objectives, which are to allow a debtor time and breathing space to facilitate a going concern solution that maximizes value for the benefit of all stakeholders.
While DIP financing is far from a new phenomenon in Canada, recent cases have shed light on several emerging issues and trends, including the judicial treatment of roll-ups and creeping roll-ups. The increasing prevalence of roll-ups in Canada is likely directly attributable to their continued use and popularity in the United States. However, cross-border restructuring professionals need to be aware of the key differences between U.S. and Canadian bankruptcy law when seeking approval of a roll-up, either in a dual plenary Chapter 11 and CCAA proceedings or in a Canadian CCAA part IV recognition of a Chapter 11 proceeding.
In Canada, roll-ups and their permutations have been hotly debated largely because there remains a serious question under Canadian restructuring laws as to their use and permissibility.3 Under a roll-up, a DIP lender’s prefiling debt or a portion thereof is paid back using proceeds from the DIP facility. The prefiling debt is thereby “rolled” into the DIP facility.
In addition to a true/full or partial roll-up, a DIP lender may also seek approval of a “creeping roll-up.” Under a creeping roll-up, instead of DIP proceeds being used directly to pay down prefiling obligations, all of the debtor’s cash from operations during the CCAA proceedings is swept by the DIP lender and used to pay down prefiling obligations. Concurrently, there is a corresponding draw on the DIP facility to fund further operations.
The judicial treatment of roll-ups and creeping roll-ups in Canada provides little insight as to their permissibility. On the one hand, it appeared that DIP roll-ups were permissible. In 2010, the Quebec Court in the CCAA proceedings of White Birch Paper Holding Co.4 approved DIP financing and a corresponding superpriority charge, notwithstanding that $50 million of the $140 million DIP proceeds would directly repay and discharge the prefiling asset-based revolving credit facility extended by the DIP lender.
In approving the White Birch DIP facility, the court noted that the priming DIP charge would not secure any obligations that were owing prior to the filing. This decision, however, is contrasted with the CCAA Part IV recognition proceedings of Hartford Computer Hardware Inc, Re,5 where the Ontario Court expressly noted that the roll-up provision would not otherwise be permissible as a result of Section 11.2 of the CCAA. That section expressly provides that a DIP charge may not secure an obligation that exists before the initial order is made.6
Following the court’s decision in Hartford, subsequent judicial decisions in Canada seemed to suggest that creeping roll-ups, rather than full roll-ups, were permissible under Section 11.2 of the CCAA. The use of a creeping roll-up appeared to be approved by the Canadian courts on the basis of maintaining the existing cash management system of the debtor in connection with an asset-based lending (ABL) facility. The approval of the continuation of existing cash management appeared to indirectly approve creeping roll-ups under the guise of ABL cash management.
In Comark,7 the Ontario Court approved a DIP financing facility which in essence provided for a creeping roll-up on the basis of an approval of the existing cash management system being used in connection with the company’s ABL facility. The existing cash management system in effect prior to the CCAA proceedings required that all cash from margin receivables be swept into a blocked account and applied to the prefiling ABL debt to free up availability for draws on the ABL loan.
The court in Comark approved the creeping roll-up in the context of the existing ABL cash management structure. Accordingly, for Comark to access liquidity in the CCAA proceedings, the company was required to deposit all cash from operations into the blocked account to pay down the prefiling revolver facility. Payments toward the prefiling revolver would result in corresponding availability under the DIP facility extended by the same prefiling secured lender.
The court accepted that because the prefiling revolver facility was only being reduced with cash Comark generated from its business, the DIP charge would only secure advances made post-filing under the DIP facility. Accordingly, the DIP charge would not secure an obligation that existed prior to the commencement of the CCAA proceedings. The approval of a creeping roll-up in Comark on the basis of maintaining the ABL cash management system was also the basis of the court’s approval of a creeping roll-up DIP in the 2016 dual plenary CCAA and Chapter 11 proceedings of Re: Golftown Canada Inc.8
In November 2016, the Ontario Court in Re: Performance Sports Group9 explicitly approved a creeping roll-up (rather than approving it on the basis of cash management in connection with an ABL facility) but drew a distinction between a roll-up and a creeping roll-up. The court noted that a creeping roll-up was permissible under the CCAA, whereas a full roll-up, which uses DIP proceeds to pay prefiling facilities, was prohibited. The court specifically noted that:
Section 11.2(1) of the CCAA provides that security for a DIP facility may not secure an obligation that existed before the order authorizing the security was made. The effect of this provision is that advances under a DIP facility may not be used to repay pre-filing obligations. In this case, the ABL DIP Facility is a revolving facility. Under its terms, receipts from operations of the PSG Entities post-filing may be used to pay down the existing ABL Facility. The applicants submit that in this case, the ABL DIP Facility preserves the pre-filing status quo by upholding the relative pre-stay priority position of each secured creditor. By requiring that the PSG Entities only use post-filing cash receipts to pay down the accrued balance under the revolving credit facility, the ABL DIP Lenders are in no better position with respect to the priority of their pre-filing debt relative to other creditors. I accept that no advances under the ABL DIP Facility will be used to pay pre-filing obligations.10 (emphasis added)
Notwithstanding the court’s statement in Re: Performance Sports Group Inc., less than a year later the Ontario Court approved a full roll-up in the dual plenary CCAA and Chapter 11 proceedings of Re: Toys R Us.11 In Toys, the court approved a roll-up whereby approximately $93 million of an outstanding prefiling ABL revolver would be paid by the CCAA applicant’s DIP facility. In approving the roll-up, the court noted that:
[W]hile it is proposed for DIP funding to be used to pay out pre-filing lenders (a “takeout DIP”) all of the loans that will be secured are fresh advances by the DIP lenders…The court-ordered charge is not being used to improve the security of the pre-filing ABL lenders or to fill any gaps in their security coverage. In my view therefore, the takeout DIP is not prohibited by s. 11.2.”12
Given the varying case law, there has yet to be judicial consensus or a fully reasoned analysis as to the permissibility of roll-ups or creeping roll-ups. The issue with respect to the uncertainty surrounding the use of roll-ups has arguably manifested as a result of the varying interpretations of Section 11.2 of the CCAA.
Section 11.2 of the CCAA provides that a DIP charge may not secure an obligation that exists before the order approving the DIP financing is made.13 A plain reading of Section 11.2 results in a narrow restriction on DIPs—that while a DIP charge cannot secure a prefiling obligation, DIP proceeds may, in fact, be used to pay down prefiling indebtedness. The payment of prefiling indebtedness is not the same as securing prefiling indebtedness.
This is consistent with the court’s decisions in White Birch and Toys. However, some insolvency practitioners would suggest that the payment of prefiling obligations using DIP proceeds (a roll-up) or using cash from operations (a creeping roll-up) indirectly permits what a debtor cannot do directly—elevate prefiling obligations to superpriority status through their payment in contravention of Section 11.2 of the CCAA.
As there are fundamental differences between the U.S. Bankruptcy Code and the CCAA, the use of roll-ups or creeping roll-ups is necessarily dependent upon the differing risks a DIP lender is trying to avoid in the U.S. or Canada. In the United States, a roll-up or creeping roll-up of a prefiling facility is often sought to avoid a cramdown of the prefiling facility.
However, in Canada, there is no concept of cramdown under the CCAA. Roll-ups can nonetheless assist a DIP lender in ensuring its prefiling loans cannot be compromised and also to protect a prefiling working capital lender that advances prefiling funds on the strength or value of a debtor’s assets, including its receivables and inventory. The logic is that if the working capital lender lent based on asset-based lending formulas, it relied on the recovery of that very collateral for its repayment. In a CCAA proceeding, the level of working capital generated may be reduced, thereby compromising the repayment of the prefiling loan.
The authors contend that roll-ups should be permissible and authorized in Canada in appropriate circumstances, and the court’s decisions in White Birch and Toys R Us provide the judicial approval for roll-ups. Notwithstanding the strength of these decisions, cross-border U.S./Canadian practitioners should be mindful that the motives/benefits for obtaining a roll-up in Canada versus the United States will differ.
In addition, to seek approval of a roll-up—whether in a dual CCAA/Chapter 11 proceeding or in a recognition of a Chapter 11 proceeding—demonstrating the following factors may be helpful in seeking approval by the Canadian court of a roll-up/creeping roll-up, which in essence requires convincing the court that there will be appropriate benefits as well as no prejudice to stakeholders as a result of the court authorization of the roll-up:
While it appears that Canada is slowly moving toward the U.S. model in that roll-ups and creeping roll-ups are more regularly approved by Canadian courts, there is still a lack of judicial consensus as to whether roll-ups and creeping roll-ups are permitted under Canadian law. U.S. restructuring professionals and lenders should be aware that: (i) approval of a roll-up or creeping roll-up is not a certainty in Canada; and (ii) there are differing uses for roll-ups in Canada relative to the United States, given that Canadian restructuring statutes do not have the concept of adequate protection or cramdown.
Notwithstanding these differences, roll-ups can still be an important feature to manage credit risk when lending to Canadian companies in an insolvency proceeding.