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The Supreme Court Finally Clarifies the Rules of Compensation in Restructuring and Sends a Clear Message to Public Bodies Seeking to Establish the Fraudulent Nature of Certain Claims

Fasken
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Overview

Insolvency and Restructuring Bulletin

On March 23, 2020, we commented on the Quebec Court of Appeal’s decision in the Arrangement relating to Consultants SM inc. case.[1] The City of Montreal (the “City”) appealed this decision to the Supreme Court of Canada and the appeal was heard on May 20, 2021.

On December 10, 2021, the Supreme Court of Canada (the “Supreme Court”) dismissed the City’s appeal, thereby rendering an important decision with respect to “pre-post compensation” and “non-dischargeable debts” under the Companies’ Creditors Arrangement Act (the “CCAA”).

Fasken’s Insolvency and Restructuring Group represented the purchaser of SM Group in successfully opposing the appeal to the Supreme Court.

More specifically, the Supreme Court concluded that an agreement entered into under the Voluntary Reimbursement Program under Bill 26 does not necessarily constitute a debt arising from fraud within the meaning of section 19(2) of the CCAA. In addition, the Supreme Court tempered the application of Kitco by concluding that, while the court may exercise its discretion to allow “pre-post compensation” in some exceptional cases, the City had not met the criteria for doing so.

Factual and procedural background

SM Group was a Quebec engineering, project management and consulting firm composed of a number of subsidiaries with operations in about thirty countries. It had approximately 700 employees and managed several hundred active contracts.

In 2017, before the restructuring process, SM Group entered into a confidential settlement agreement with the City of Montreal under the Voluntary Reimbursement Program (the “VRP”) under the Act to ensure mainly the recovery of amounts improperly paid as a result of fraud or fraudulent tactics in connection with public contracts (“Bill 26”). This agreement provided that SM Group would pay amounts over several years to the City of Montreal (the “City”) as a voluntary reimbursement (the “VRP Claim”). It should be noted that under the terms of Bill 26, a settlement under the VRP is made on a “without admission” basis and does not constitute an admission of liability.

In August 2018 a restructuring process under the CCAA was commenced in respect of SM Group, and Restructuring Deloitte Inc. was appointed monitor (the “Monitor”).

At the start of the restructuring proceedings, it was determined that the process to sell SM Group’s assets should be commenced. FNX-Innov Inc. and some subsidiary companies were quickly identified as the interested purchasers (the “Purchaser”), and in November 2018 the Court issued a vesting order approving the transaction to sell SM Group’s assets to the Purchaser. The assets purchased included over 1,739 SM Group contracts and SM Group accounts receivable.

Between the issuing of the initial order and the sale of the assets, SM Group had performed work for the City in connection with certain contracts, which SM Group assessed at $825,892.20 (the “SM Claim”). The SM Claim was assigned to the Purchaser as part of the transaction.

The City took the position that the SM Claim did not have to be paid to the Purchaser following the transaction on the basis that the transaction could legally set off the SM Claim against two claims: (1) the VRP Claim, and (2) a claim arising from an action filed after the start of the restructuring proceedings with regard to SM Group and the other defendants in which the City alleged the existence of a system of collusion in connection with awarding a contract to install water meters (the “Water Meter Claim”).

The City argued that it could effect this set-off despite the Quebec Court of Appeal’s finding in Kitco that such “pre-post compensation” is not permissible, on the basis that the VRP Claim was a non-dischargeable debt that was an exception to the rule established in Kitco.

After this action was taken by the City, the Monitor filed an application for declaratory relief in order to ask the Superior Court to confirm that the City could not effect compensation as it claimed and order it to pay the SM Claim.

Lower courts

At trial, Justice Corriveau granted the Monitor’s application, dismissing the City’s arguments and ordering the City to pay the SM Claim. However, in her reasons, Justice Corriveau stated that, despite the wording of Bill 26 and the VRP Agreement, the VRP Claim was indeed a debt arising out of fraud within the meaning of section 19(2) of the CCAA that could not be compromised by a plan of arrangement without the express consent of the City. On the other hand, despite the “non-dischargeable” nature of the VRP Claim, the compensation requested by the City could not be effected between pre-debt and post-debt.

The City requested and obtained leave to appeal that judgment.

The majority of the Court of Appeal dismissed the City’s claims, thereby upholding the position of the Purchaser. Relying on the principles laid down by the Court of Appeal in Kitco, the Court of Appeal reiterated that it was impossible to effect compensation between pre-filing and post-filing claims. Moreover, contrary to Justice Corriveau’s findings, the Court of Appeal found that the VRP Claim was not a debt contemplated by Section 19(2), and thus was not a non-dischargeable debt.

As for the Water Meter Claim, the Court of Appeal held that legal compensation could not be effected because the claim was neither certain nor liquid nor exigible at the start of the insolvency proceedings.

Supreme Court of Canada decision

Six of the seven Supreme Court judges dismissed the City’s appeal.

The Supreme Court confirmed the Court of Appeal’s analysis that the VRP Claim did not fall within the scope of section 19(2) of the CCAA, since the City had not provided any evidence to that effect, and since the text of the VRP and the VRP Agreement did not support that argument. The Supreme Court stated that the mere fact of participating in the VRP could not be considered evidence of fraud and there were several reasons why a company might participate:

[42] Lastly, it should be mentioned that it can easily be imagined that an enterprise that entered into a potentially contentious public contract with a public body would make the strategic choice to participate in the VRP out of fear of bad publicity or to avoid exposing itself to the exceptional scheme of Chapter III of Bill 26, the result of which, if the proceeding were decided in the public body’s favour, would likely be significant additional financial liability for the enterprise on top of the legal fees it would have to pay.

 Next, the Supreme Court tempered the Kitco rule prohibiting “pre-post compensation” in restructuring under the CCAA. According to the Supreme Court, although the stay of proceedings also stayed the compensation between “pre” and “post” debts, courts retain the discretion to lift the stay based on the particular facts of each case. However, the Court had to be cautious “given the high disruptive potential of this form of compensation.” The Supreme Court stated that, generally, the prejudice suffered by a creditor wishing to effect “pre-post compensation” does not justify broadening the scope of the rules of compensation:

[72].The prejudice suffered by a creditor wishing to effect pre‑post compensation does not justify expanding the scope of s. 21. When the debt owed by the creditor arises after a stay order has been made, prejudice is merely illusory. The fact that the creditor contracted obligations toward the debtor company during the stay period does not place it in a worse situation than it would have been in had it contracted with a third party instead. If it had contracted with a third party, it would likewise have had to pay the full price of the goods or services it obtained (Tungsten (S.C.), at para. 27). A creditor that contracts with the debtor company during the status quo period knows or ought to know that it will probably receive only pennies on the dollar in payment of its pre‑order claim and that payment of its post‑order debt will benefit it and the other creditors.

In this case, however, the Supreme Court concluded that it would not be appropriate to lift the stay exceptionally, and that the trial judge should not have exercised her discretionary power to do so, as the cumulative criteria in Callidus had not been met, namely: (1) that the order sought was appropriate in the circumstances, and (2) that the applicant had been acting in good faith and (3) with due diligence.[2] According to the Supreme Court, it was not appropriate to lift the stay of proceedings, as the City had only an unsecured claim given its failure to prove the alleged fraud. The City erred when it conflated its interest as a creditor with the public interest, despite the fact that it is a municipality.[3] Its claim that the objective of protecting the public interest militated in favour of pre-post compensation had therefore to be rejected. Nor did the City act with the required diligence when it waited at least 47 days before mentioning, for the first time, that it did not intend to pay for the services rendered by SM Group after the initial order:

[92] In this case, it is clear that the City did not act in accordance with the standard of diligence expected in CCAA proceedings. On this point, Deloitte submits that the City should have given notice of its intention to effect compensation in the days after the initial order was made on August 24, 2018. The record does not show that the City learned of the initial order on August 24, 2018, but, as indicated in an email to counsel for Deloitte, the City was aware of the existence of that order by at least September 10, 2018. Whatever the case may be, we are of the view that a diligent creditor, after learning of the debtor’s insolvency when it is subject to proceedings under the CCAA, cannot wait 47 to 58 days to notify the debtor of its intention to effect compensation.

[93] The City justifies the lateness of its application by stating that it was waiting for one of the payments on the VRP claim, which was due on October 31, 2018, before taking any action. Yet the VRP agreement indicates that the payment in question was actually due on October 1, 2018. Furthermore, the City knew or ought to have known that the term had already expired several weeks earlier, as SM Group’s insolvency had resulted in the loss of the benefit of the term of the VRP claim.

[94] Whether intentional or not, this inaction on the City’s part tended to place it in a better position than other ordinary creditors at what, we should point out, was a critical time in the restructuring process. By invoking compensation, the City could obtain services without paying for them. The City had to suspect that if it had indicated its intention to proceed in this manner right from the start, as due diligence requires, SM Group would likely have refused to undertake the work provided for in the contract, knowing that it would not be paid and that this would be a major stumbling block in the interim financing process. What is more, under s. 32 of the CCAA, SM Group could even have asked that the contract be resiliated.

[Emphasis added.]

In light of its conclusions with respect to the first two criteria, the Supreme Court did not deem it necessary to analyze whether the City had acted in good faith or not.

Lastly, for the same reasons as those relating to the VRP Claim, i.e. lack of appropriateness and diligence, the Supreme Court confirmed that the City could not withhold the amounts owed to SM Group until a judgment had been obtained on the Water Meter Claim, thus confirming the previous decisions in this matter.

Conclusion

This recent Supreme Court decision explicitly clarifies once and for all the issue of “pre-post compensation” in the context of a restructuring under the CCAA. Although the Supreme Court opens the door for a supervising judge to exercise discretion in authorizing “pre-post compensation,” it is to be expected that this opening will be very narrow and limited to highly exceptional situations.

This case also gave the Supreme Court the opportunity to analyze some provisions of Bill 26 and its regulations for the first time. It allowed the nation’s highest court to clarify the burden of proof on public bodies when they attempt to establish the fraudulent nature of a claim arising from an agreement under the VRP. Individuals or companies that have entered into a VRP settlement will therefore be relieved to know that their mere participation in the VRP will not create a presumption of admission that they have committed a fraudulent act. Public bodies will need to do their duty and prove that VRP participants knowingly made false representations that led to VRP claims.

Fasken advised the Purchaser with a team comprised of Luc Béliveau, Marc-André Morin, Nicolas Mancini and Éliane Dupéré-Tremblay.



[1] 2020 QCCA 438.

[2] 9354-9186 Québec Inc. v. Callidus Capital Corp., 2020 SCC 10, para. 49.

[3] Supreme Court decision, para. 88.

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