“When a business becomes insolvent, many interests are at risk. Creditors may not be able to recover their debts, investors may lose their investments and employees may lose their jobs. If the business is the sponsor of an employee pension plan, the benefits promised by the plan are not immune from that risk. The circumstances leading to these appeals show how that risk can materialize. Pension plans and creditors find themselves in a zero-sum game with not enough money to go around. At a very general level, this case raises the issue of how the law balances the interests of pension plan beneficiaries with those of other creditors.” 1
On February 1,2013, the Supreme Court of Canada released its much anticipated decision in Sun Indalex Finance, LLC v. United Steelworkers, a case which pitted the claims of pensioners against those of secured creditors in the context of the insolvency of the employer plan sponsor.
Pensioners Lose the Battle but Win the War?
The Supreme Court’s decision in Indalex largely overturned the Ontario Court of Appeal’s earlier decision in this matter, which was resolved in favour of the pensioners’ claims, and that had created uncertainty for lenders, insolvency practitioners and participants in the pensions industry. While the Supreme Court ultimately decided Indalex in favour of the secured creditors, it appears to have facilitated a greater role for plan members in insolvency proceedings in the future. And although the Supreme Court clarified a number of the uncertainties arising from the Ontario Court of Appeal’s decision, it may have raised more questions than it answered.
Briefly, the Supreme Court made the following findings:
the deemed trust provisions in the Ontario Pension Benefits Act (the PBA) apply to the entire amount the employer is required to pay under the PBA with respect to a pension plan wind up deficiency;
as a result of the doctrine of federal paramountcy, an order made in a CCAA proceeding giving priority to a debtor-in-possession (DIP) charge over a provincial deemed trust is effective; and
Indalex’s interests as a corporation came into conflict with its fiduciary duties as a plan administrator during certain stages of the insolvency proceedings, and Indalex breached its fiduciary duties by not properly dealing with this conflict; however, imposing a constructive trust in respect of the pension wind up deficiency was not an appropriate remedy for such breaches.
The decision is significant and brings needed clarity to the issues of paramountcy and the scope of the PBA deemed trust in the wake of the Ontario Court of Appeal ruling. However, the Supreme Court has left a number of questions unresolved relating to the application of the deemed trust to wind ups declared with retroactive effect and relating to pension governance,, posing potential challenges for employers that carry out a dual role as plan sponsor and plan administrator.
Indalex Limited (Indalex) obtained creditor protection under the Companies’ Creditors Arrangement Act (CCAA) on April 3, 2009. A few days later, on April 8, 2009, the CCAA Court authorized Indalex to obtain DIP financing, providing Indalex with loans to allow it to continue to operate its business during the restructuring period. The CCAA Court ordered that the DIP lenders had a “super-priority” over existing debt, equity and other claims, and stated expressly that this included statutory deemed trusts and statutory liens. The DIP loan was also guaranteed by Indalex U.S.
Indalex brought a motion for the approval of the sale of its assets and for approval to the distribution of the sale proceeds to the DIP lenders. At the distribution approval hearing on June 20, 2009, two groups of pension claimants opposed the proposed distribution to the DIP lenders, claiming that Indalex assets equal to the funding deficiencies in two defined benefit pension plans sponsored and administered by Indalex (the “Salaried Plan” which had been wound up and the “Executive Plan” which, at that time, had not) were deemed to be held in trust and should be remitted to the plans in priority to the DIP lenders.
The CCAA Court approved the distribution of the sale amounts to the DIP lenders subject to the monitor holding, pending resolution of the pension issues, a reserve sufficient to cover the deficiencies in the Salaried Plan and Executive Plan. Indalex U.S. paid the DIP lenders the amount outstanding on the loan, pursuant to its guarantee, and as a result Indalex U.S. inherited the rights of the DIP lenders to be paid from the assets of Indalex. As a result, Indalex U.S. then claimed the portion of the sale proceeds held back by the monitor in a reserve account, and the two groups of pension claimants continued to argue that these moneys should be paid to the pension plans.
Ontario Court of Appeal Decision
The Ontario Court of Appeal examined the provisions of the PBA which imposed a deemed trust where a pension plan is wound up and held that those deemed trust provisions applied to all amounts the employer was required to pay to liquidate pension plan wind up liabilities. The Court of Appeal then concluded that the amount that was subject to the deemed trust should be paid in priority to amounts owing to the DIP lenders, notwithstanding their super priority. The Ontario Court of Appeal also concluded that Indalex had breached its fiduciary obligations to members of the Salaried Plan and Executive Plan and that the appropriate remedy for their breaches of fiduciary duty was to impose a “constructive trust” over Indalex’s assets in the amount of the wind up deficiencies in the Plans.
Supreme Court of Canada Decision
The Supreme Court largely focused on the following issues: (i) the scope of the PBA deemed trust; (ii) the priority of the deemed trust in relation to the DIP charge; and (iii) any breach of fiduciary duty and the appropriate remedy for such a breach.
Scope of Deemed Trust
In considering whether the statutory deemed trust provided for in s. 57(4) of the PBA extended to wind up deficiencies, the (4-3) majority focused on the “wording, context and purpose” of s. 75 of the PBA. Section 75 requires the employer of a wound up plan to pay into the pension fund an amount equal to the total of all payments due or accrued to the fund that have not yet been paid (s.75(1)(a)) plus any additional amounts relating to the shortfall between the value of certain benefits and the assets available to pay those benefits in respect of Ontario plan members (s. 75(1)(b)).
The majority noted that s. 75(1)(b) required the employer to pay an “amount” that is based on the value of the assets and liabilities that had accrued as of the plan wind up. The majority held that this provision did not require all liabilities to be calculable as of the wind up date. Rather, in the majority’s view no pension entitlements could arise after the date of the wind up and as such, “a contribution has ‘accrued’ when the liabilities are completely constituted, even if the payment itself will not fall due until a later date.” Thus, the majority concluded that “wind-up deficiency contributions” are subject to a deemed trust as of the wind up date, regardless of any amortization period available under the PBA to fully pay such contributions.
The majority found further support for this position when reviewing the history of the PBA, which, in their view, demonstrated an expansion of the deemed trust concept over the years, and the remedial nature of the PBA deemed trust provisions, which supported a broader approach to their interpretation.
While the majority made it clear that an actual wind up is required in order for the deemed trust to apply (i.e., it does not apply to a going concern or a solvency deficiency), questions remain as to whether the same conclusion applies even if the pension plan wind up is ordered after the CCAA proceedings have commenced. For example, would the deemed trust apply where after CCAA proceedings have commenced, the Superintendent of Financial Services (the Superintendent) issues an order to wind up a pension plan with an effective date prior to the date the CCAA proceeding commenced. A related question is whether the Superintendent would even be able to issue such a wind-up order or whether he would be constrained by any stay of proceedings orders that have been made as a part of such CCAA proceedings?
Priority of Deemed Trust and DIP Charge
Turning to the matter of priority, the Supreme Court unanimously agreed that the super-priority of the DIP charge made under the CCAA prevailed over the PBA deemed trust on the basis of the doctrine of federal paramountcy.
Breach of Fiduciary Duty
Notwithstanding the Supreme Court’s finding that the DIP financing charge superseded the PBA deemed trust, it was necessary for the Court to consider whether an equitable remedy, which could override all of the priorities, should be ordered for any breach by Indalex of its fiduciary duty to the plan beneficiaries. While Justices Deschamps and Cromwell wrote separate concurring decisions regarding the breach of fiduciary duty, they largely agreed with respect to the following findings:
Scope of the Conflict of Interest
The Court of Appeal interpreted the potential for conflict of interest and the fiduciary duty of a plan administrator too broadly. For example, Indalex’s decision to seek the initial stay under the CCAA did not in and of itself give rise to a conflict of interest. The majority recognized this initial application as an “emergency situation” requiring immediate action by Indalex.
According to Justice Cromwell, “a situation of conflict of interest occurs when there is a substantial risk that the employer-administrator’s representation of the plan beneficiaries would be materially and adversely affected by the employer-administrator’s duties to the corporation.” Once Indalex began to take actions as a part of the CCAA proceedings that could impact its ability to fund the pension plans (e.g., seeking authorization for the DIP charge), the potential for plan beneficiaries to be adversely affected arose and Indalex’s corporate interests came into conflict with its duties as a plan administrator.
Two Hats Theory
While the majority recognized the “dual role” of an employer-administrator and the potentially competing duties to the corporation and to the plan members, they rejected any argument that Indalex could disregard the potential conflict of interest when wearing its “corporate hat”. Justice Deschamps, in particular, was critical of the “two hats theory”, noting that once Indalex found a conflict of interest, it had a duty as a plan administrator to find a solution that ensured the plan members’ interests were protected.
The potential solutions to the conflict of interest, as suggested by the Supreme Court, varied. Justice Deschamps held that any solution had “to fit the problem” and may differ in every case, requiring Indalex to consider options ranging from providing notice of the DIP financing motion to the members, to appointing a replacement administrator or representative counsel. Justice Cromwell suggested a mandatory obligation on the debtor to bring the conflict to the attention of the CCAA judge to take advantage of the expertise and knowledge of CCAA judges in determining how best to ensure that the interests of the plan beneficiaries are fully represented. While Justice Cromwell suggested that the CCAA judge could choose to appoint a replacement administrator, he seemed to accept that it could be sufficient if the employer/administrator conducted itself as if they are an independent administrator. Justice LeBel (in dissent) went so far as to find that Indalex should have resolved its conflict of interest by immediately abandoning its role as plan administrator and diligently transferring its functions to an independent administrator.
Notwithstanding Indalex’s breach of its fiduciary duty, a majority of the court (5-2) agreed that the constructive trust ordered by the Ontario Court of Appeal was not an appropriate remedy in these circumstances. In particular, both justices noted that there was no property or assets which arose as a result of “the wrongdoer’s acts”.
Conflicts of Interest
While the Supreme Court was unanimous in holding that Indalex had breached its fiduciary duties to the pension plan beneficiaries, it appears to have struggled somewhat with identifying which conflicts led to breaches of duty and hence the time when those conflicts arose, the extent to which the legislative regime permitted conflicts and the steps that would need to be taken (and when) to avoid, obviate or eliminate the conflicts. Nonetheless, plan sponsors may take some comfort in these findings of the majority:
Indalex’s failure to provide plan beneficiaries with reasonable notice of its motion to apply for the DIP Loan was a clear moment when there was a breach of fiduciary duty; and
the dual role of an employer as plan sponsor and plan administrator is entrenched under pension legislation, as is the potential for conflicts of interest to arise during the course of a company discharging its specific, and sometimes contemporaneous, duties in respect of each role
Appointing a Replacement Administrator
The suggestion that a replacement administrator could be appointed as a solution for any conflicts of interest that the employer-administrator has to deal with in properly managing its dual role under the pension plan seems a reasonable option in theory. However, there are a number of legal and practical considerations to be addressed in assessing the merits of this option.
Pension legislation sets specific limits on who is eligible to be a plan administrator and, in the context of most single employer private sector pension plans, the employer sponsor is the plan administrator.
While plan administrators may delegate administrative tasks and decisions to qualified committees, individuals and third parties, provincial and federal pension legislation does not allow a plan administrator to simply appoint an independent company to replace the employer as administrator.
Pension legislation permits the pension regulator to appoint a replacement third party administrator in specific circumstances (e.g., in Ontario following a plan wind up declaration where the plan administrator fails to act); however, at least in Ontario, broader provisions permitting the regulator to appoint an administrator in “prescribed circumstances” are not yet in force and there is no indication as to whether these prescribed circumstances will include situations where potential conflicts of interest arise. Even for federally regulated pension plans the regulator has, to date, been reluctant to appoint a replacement administrator where the current administrator is a going concern.
Pension Plan Governance
The “two hats” doctrine, which focused on situations where there could be a conflict between the company’s role as plan sponsor and plan administrator, appears to have been refined by the Supreme Court. They have provided some guidance, in the context of insolvency proceedings, on what situations might lead to a conflict of interest where a company is carrying out the dual roles of employer and administrator. There is, however, less guidance on what the company must do if faced with a conflict of interest outside an insolvency proceeding.
Although the Indalex decision recognizes that the PBA permits the continuation of dual roles, the decision appears to require: (i) a substantive analysis by the employer of the potential effect of any decision making on plan beneficiaries; and (ii) measures to be taken to avoid any conflicted decision making or at least independent representation of the beneficiaries’ interests. Plan administrators may want to consider putting protocols in place to identify potential conflicts and the process for dealing with them through notice or other means.
1 The Honourable Mr. Justice Albert Thomas Cromwell.