Critical Supplier Priority Charges in CCAA Restructurings

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Companies restructuring under the Companies’ Creditors Arrangement Act (“CCAA”) depend on a supply of critical products and services in order to continue operations during the proceedings. An interruption in the supply of such goods and services would likely be fatal to any restructuring. Prior to 2009, the CCAA was silent about how the post-filing supply of such goods and services was to be obtained. The CCAA provided only that a supplier could not be forced to supply on credit. Most suppliers required cash on delivery, cash in advance or a letter of credit delivered by the lenders that had agreed to provide a DIP loan to the insolvent company.

2009 Amendments – Court May Order that Charge Ranks in Priority to Secured Creditors

As part of the overhaul of the CCAA in 2009, the concept of “critical suppliers” was added to the CCAA. Pursuant to section 11.4 of the CCAA, on an application by a debtor company, a court can make an order declaring that a supplier is a critical supplier if the court is satisfied that the supplier provides a supply of goods or services that is essential for a company’s ongoing operations. Further, a court can compel critical suppliers to supply goods or services to a debtor on the terms and conditions that the court considers appropriate. If a court order compels a critical supplier to supply goods and services, a court must declare that all or part of the debtor’s property is subject to a security or charge in favour of the critical suppliers pursuant to subsection 11.4(3). The court may order that the charge ranks in priority over the claim of any secured creditor. Notice must be given to secured creditors who will be affected by the order.

The 2009 amendments change the circumstances surrounding stakeholders in a CCAA proceeding. An insolvent company no longer needs to rely on the credit of its DIP lender for all of its post-filing needs, but can instead rely on the credit of critical suppliers. This may reduce the cost of short term liquidity for an insolvent company as the company may not be required to draw on its DIP loan as frequently and may have less need of funding. In addition, unlike DIP lenders, critical suppliers designated pursuant to section 11.4 do not negotiate their position with the insolvent company and have no greater rights to information or access to the debtor than unsecured pre-filing creditors.

Recent Judicial Consideration of “Critical Supplier” Provisions of CCAA

Canadian courts have considered the application of section 11.4 in a number of recent proceedings. The CCAA proceedings of the Priszm group of companies (the “Priszm Proceedings”) involved an applicant that operated several hundred fast-food franchises. These franchises required the continual supply of numerous goods and services, such as food products, waste management, information technology and utilities.

The applicant sought an order declaring certain suppliers to be critical suppliers and requiring them to continue supplying on terms and conditions consistent with past practice and existing arrangements. The applicant also requested a charge as security for payment for the goods and services to be supplied. The court granted the order based on the applicant’s reliance on an uninterrupted flow of these supplies and the fact that any interruption of the supply would negatively impact the applicant’s ability to restructure. The court declared that certain parties were critical suppliers because their failure to supply would have had an immediate material adverse impact on the company’s business, operations and cash flow.

The CCAA proceedings in respect of Catalyst Paper demonstrate additional factors that a court will consider in making an order designating certain parties as critical suppliers. Catalyst Paper was a manufacturer of paper products. Paper production requires specialized equipment, numerous raw materials, a significant amount of energy and utilities, and numerous other inputs. Proceedings under the CCAA were commenced at the end of January 2012. Shortly thereafter, the court issued an order pursuant to section 11.4 of the CCAA designating some 16 suppliers as critical suppliers, ordering them to continue supplying goods and services to Catalyst Paper and granting a charge in their favour.

The company persuaded the court to declare that various suppliers were critical suppliers under section 11.4 by listing numerous reasons why the maintenance of pre-filing relations with suppliers was necessary for the company’s continuing operation. Reasons included that Catalyst Paper kept low levels of inventory on hand, delayed or stopped supply could disrupt Catalyst Paper’s operations, there were no alternative suppliers available for some of the goods and services, and Catalyst Paper’s business depended on the ongoing supply of certain goods and services.

A review of cases dealing with section 11.4 shows that courts apply this provision by assessing a debtor’s business needs. Each time a court has considered section 11.4, it has focused its reasoning on an examination of the impact of an interruption of supply on the debtor’s continued operations and its ability to restructure. Companies applying for a critical supplier declaration must make a business case to the court that demonstrates a supplier’s importance to its restructuring and operational success.

In Re Northstar Aerospace, Inc., the court recognized a limitation on court orders made under section 11.4. The court observed that an order compelling supply may not suffice to ensure a timely supply by a critical supplier located in a foreign jurisdiction. Northstar Aerospace Inc. (“Northstar”) was a manufacturer of components and assemblies for military and commercial aircrafts. Its operations were dependent, in part, on an ongoing supply of certain components provided by a supplier located in China. The court permitted Northstar to pay its pre-filing debt to the critical supplier despite also making an order under section 11.4 that compelled the critical supplier to supply goods to Northstar, given that the court could not ensure timely supply otherwise. This approach is aligned to the practical nature of the CCAA but may also open the door for suppliers to challenge compelled supply and demand payment for pre-filing debt.

Section 11.4 may give companies proceeding under the CCAA the benefit of improved short term liquidity and potentially lower borrowing costs. In contrast, compelled supply may force unwilling parties to supply on credit to insolvent companies without providing any protection beyond a critical supplier charge. It will be interesting to see how the courts strike a balance between the interests of the insolvent company, the interests of suppliers and the interests of other stakeholders in CCAA proceedings when granting orders under section 11.4.

Published In: Administrative Agency Updates, Business Organization Updates, General Business Updates, Finance & Banking Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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