SCC Ruling Affirms Authority to Approve Litigation Funding Agreement as Interim Financing

In a ruling from the bench, with reasons to follow, the Supreme Court of Canada unanimously allowed on January 23, 2020, the appeal from the Quebec Court of Appeal’s decision in 9354-9186 Québec Inc. v. Callidus Capital Corporation[1], confirming the authority of a supervising court acting pursuant to the Companies’ Creditors Arrangement Act, R.S.C., 1985, c. C-36 (“CCAA”) to approve litigation funding agreements outside of a formal plan of arrangement and granted a super-priority charge against the proceeds of a claim. The Court restored the decision of CCAA judge Jean-François Michaud[2], who approved a litigation funding agreement between the debtors and a litigation financier, enabling it to pursue a claim against one of its creditor.

Background

The appellants 9354-9186 Québec Inc. et al. (“Bluberi”) specialized in electronic gaming machines. In 2012, Bluberi signed a loan agreement with the respondent Callidus Capital Corporation (“Callidus”) that lent approximately $86 million through credit facilities between 2012 and 2015. According to Bluberi, Callidus was largely responsible for its ensuing financial difficulties.

In 2015, Bluberi filed a petition for the issuance of an initial order under the CCAA, which was granted by the Superior Court. Later, Bluberi was authorized to sell all its assets to Callidus, which was settled through a reduction of Callidus’ debt. The purchase extinguished all but $3 million of Callidus’ secured claim against Bluberi. Bluberi also retained its right to pursue its claim against Callidus.

In 2017, Bluberi sought to obtain the necessary orders to finance their litigation against Callidus. Callidus responded by filing a motion to hold a creditors’ meeting to propose a plan of arrangement. Callidus’ plan, which provided for a distribution of approximately $2.6 million to the creditors in exchange of a full release in its favour, was submitted to a vote but the 66 2/3% threshold of section 6 CCAA was not met.

Thereafter, Bluberi sought the authorization for a litigation funding agreement with the appellants Bentham IMF. Callidus responded by filing a motion to convene again a creditors’ meeting to hold a vote on its new plan of arrangement. This time, Callidus announced its intention to value its $3 million security at nil to exercise its right to vote as an unsecured creditor.

Ernst & Young Inc. acted as the court appointed monitor to Bluberi. It provided reports and recommendations to the CCAA judge concerning all the key steps of the restructuring including the sale process, the sale transaction, the initial plan of arrangement by Callidus and, ultimately, the approval of the proposed litigation funding agreement by way of its fifteenth report, which included a confidential waterfall analysis simulating distribution of proceeds under said litigation funding agreement according to varying outcomes of the proposed litigation against Callidus.

The Quebec Court of Appeal held that the impugned litigation funding agreement constituted a “plan of arrangement” and by necessary implication needed to be approved by the statutory majorities of creditors and subsequently be sanctioned by the Court. On this issue, the Quebec Court of Appeal appeared to sidestep the ruling of the Ontario Court of Appeal in Crystallex (Re)[3] by holding that (at paragraph 85):

“I do not subscribe to a restrictive definition of what constitutes an arrangement. There is no justification in the statute, nor consistent support in the practice or case law for such a vie. The term should be given a broad interpretation appropriate to the remediate purpose of the CCAA. An arrangement or proposal can encompass both a compromise of creditors’ claims as well as the process undertaken to satisfy them.”

Issues before the Court

It unclear whether the Court will address all the issues germane to Callidus’ right to vote, including classification of creditors, scope of “related parties” under sections 4(2) and 4(3)(c) of the Bankruptcy and Insolvency Act (“BIA”) and the use of the “improper purpose” doctrine. Each issue may have far-reaching impact: 

• Absence of Commonality of Interest: Callidus sought to (1) value its security at nil, (2) vote in the same class as other unsecured creditors, (3) forego its dividend under the proposed plan, and, in exchange, receive a release from Bluberi’s claim. It is apparent that Callidus wanted a release at lowest cost, while the unsecured creditors’ wanted to maximize their payout. The Supreme Court was asked to determine whether Callidus shared a sufficient commonality of interest with the other unsecured creditors to be permitted to vote in the same class.
• Related Party: A creditor is related to the debtor under section 22(3) CCAA if they are “related persons” under section 4 BIA. A creditor “related” to the debtor is prohibited from voting on a plan. Callidus had a pledge on all of Bluberi’s shares, which raised the question whether Callidus was “related” to Bluberi, therefore barring Callidus’ right to vote on its proposed plan.
• Proper Application of Doctrine of Improper Use: Justice Michaud used his discretion to remove Callidus’ right to vote on its own plan because Callidus’ behaviour was contrary to the “requirements of appropriateness, good faith, and due diligence [that] are baseline considerations that a court should always bear in mind when exercising CCAA authority.”[4] At issue was whether the residual discretion afforded to CCAA courts in finding “improper purpose” was properly used.

While we await the reasons from the Supreme Court of Canada, one immediate takeaway is that CCAA courts have the authority to approve a litigation funding agreement outside of a formal plan of arrangement. This decision is important as it cements the use of litigation funding in the insolvency context and confirms that the CCAA judge has the discretion to determine whether a litigation funding agreement should be put to a creditors’ vote. It is also the first time Canada’s highest court has considered litigation funding in any context. By reversing the ruling of the Quebec Court of Appeal and restoring the conclusions of the CCAA judge, the Supreme Court of Canada will also certainly revisit the Crystallex case where the Ontario Court of Appeal identified the question at issue as the scope of financing which the supervising judge can or should approve, without the sanction of creditors. On this issue, it is expected that the Supreme Court of Canada will follow the Crystallex reasoning and limit the definition “plans of arrangement” to the compromise of creditors’ claims without expending the scope of this notion to the compromise of creditors’ claims, as well as the process undertaken to satisfy them. During arguments, the Supreme Court of Canada noted that the CCAA judge had not specifically considered the analysis of the factors set out by subsection 11.2(4) of the CCAA, but that the evidence considered by the CCAA judge was nonetheless sufficient to approve a super-priority charge in favour of the litigation funder.    

 

[1] Arrangement relatif à 9354-9186 Québec inc. (Bluberi Gaming Technologies Inc.), 2019 QCCA 171.

[2] Arrangement relatif à 9354-9186 Québec inc. (Bluberi Gaming Technologies Inc.) -and- Ernst & Young Inc., 2018 QCCS 1040.

[3] Crystallex (Re), 2012 ONCA 404.

[4]       Ibid at para 48.