The Ontario Superior Court of Justice (Commercial List) (the “Court”) in Re Harte Gold Corp.,^[1] issued its first published decision on the use of reverse vesting orders (“RVOs”) finding that the Companies’ Creditors Arrangement Act (“CCAA”) provides courts with clear jurisdiction to issue RVOs and further detailing criteria by which courts should consider the appropriateness of RVOs in future transactions^[2]

• Over the course of the past 2 years, RVOs have become increasingly popular in the context of insolvency proceedings, as they allow for the completion of going concern sale transactions in a timely and efficient manner by effectively allowing the transfer or issuance to a buyer of all of the shares of a debtor company, while vesting out unwanted assets, contracts and liabilities to an entity formed for the purpose of the transaction.
• In early 2022, after having completed a competitive sale and investment solicitation process (the “SISP”), Harte Gold Corp. (“Harte Gold” or the “Company”) proposed to complete a going concern sale transaction (the “Sale Transaction”) pursuant to a reverse vesting structure, whereby its first ranking secured creditor would subscribe for new shares in the Company (while the existing shares would be cancelled), and certain assets, contracts and liabilities would be vested out of the Company to newly formed entities (the “ResidualCos”).
• After having considered appropriateness of the Sale Transaction (including its proposed structure), the Court issued a RVO and provided detailed reasons on the court’s jurisdiction to grant RVOs and the criteria by which courts should evaluate RVOs in the future, noting, however, that practitioners should not regard the employment of RVO structures as the “norm” in future transactions.

Background

Last year, we provided a report on the increasing use of RVOs to effect restructuring transactions across Canada (Read More). At the time, while RVOs had been used in numerous transactions in provinces across the country, mostly in uncontested matters, only courts in British Columbia^[3] and Quebec^[4] had published reasons on the court’s jurisdiction to grant RVOs. In the matter of Re Harte Gold Corp., the Ontario Superior Court of Justice (Commercial List) was the latest court to endorse the use of RVOs to complete restructuring transactions in CCAA proceedings and provided further guidance for other courts to rely upon in future transactions.

The Harte Gold Transaction

Harte Gold, a public company which operated a gold mining operation located in northern Ontario, filed for creditor protection under the CCAA on December 7, 2021. At the time of its CCAA filing, the Company had conducted a strategic process for the past several months which resulted in the Company entering into a subscription agreement with its senior secured creditor that was proposed to be used as the staking horse bid in the context of a court supervised SISP. The subscription agreement contemplated a reverse vesting structure whereby the purchaser would acquire the Company’s business and operations, “free and clear” of certain designated assets, contracts and liabilities. Following the submission of a competing bid prior to the SISP and intensive negotiations between the parties, the Company ultimately entered into a first amended and restated stalking horse subscription agreement with its senior secured creditor, the execution of which was ultimately approved by the Court for the purpose of allowing the Company to conduct a SISP, with the assistance of the Court-appointed monitor.

As part of the SISP, the Company received a qualified bid from its junior secured creditor leading the Company to again enter intensive negotiations with both interested parties which ultimately led to the resolution of certain disputes between the Company’s secured creditors and the execution by the Company of a second amended and restated subscription agreement with its senior secured creditor which provided for additional consideration in favour of the Company and its stakeholders.

The Company subsequently applied for the approval of the second amended and restated subscription agreement which was to be completed pursuant to a reverse vesting structure whereby: (a) the Company would issue new shares in favour of the purchaser and cancel of all of its outstanding shares, and (b) certain designated assets, contracts and liabilities would be “vested out” to the ResidualCos, all in consideration of the payment or satisfaction by the purchaser of all secured debt and priority payables (either in cash or by way of credit-bid), the payment of substantially all pre-filing and post-filing trade amounts, the assumption of several contracts (including various royalty and offtake agreements) and the retention of substantially all of the Company’s employees. Ultimately, the value of the consideration payable by the purchaser under the Sale Transaction was contemplated to be excess of $160 million.

The Ontario Court’s Decision

On January 28, 2021, the Court approved the above sale transaction proposed by the Company and later published detailed reasons on the use of RVOs as a restructuring tool. In its decision the Court found that section 11 of the CCAA “clearly provide[d] the court with jurisdiction to issue” a RVO, noting, however, that “the discretion available under s. 11 [of the CCAA] [should be] exercised in accordance with the objects and purposes of the CCAA”. Like the British Columbia Supreme Court’s decision in Re Quest University Canada^[5], the Court stated “that the analytical framework of s. 36(3) [of the CCAA] for considering an asset sale transaction… should be applied, with necessary modifications, to an RVO transaction” even though “s. 36 may not support a standalone basis for jurisdiction in an RVO situation.”

Recognizing that the exercise of its discretion under section 11 of the CCAA has limits and must accord with the objective of the CCAA and other insolvency legislation across Canada^[6], the Court cautioned that the use of RVOs should involve close scrutiny and not become the “norm or something that is routine or ordinary course” simply because it may be more convenient or beneficial to the purchaser. The Court stated that courts and monitors should be diligent in ensuring that the restructuring is fair and reasonable to all parties having regard to the objectives and statutory constraints of the CCAA. In addition to evaluating the criteria for approval of a sale under section 36 of the CCAA, the debtor, the purchaser and especially the monitor, must be prepared to answer questions such as:

1. Why is the RVO necessary in this case?
2. Does the RVO structure produce an economic result at least as favourable as any other viable alternative?
3. Is any stakeholder worse off under the RVO structure than they would have been under any other viable alternative? and
4. Does the consideration being paid for the debtor’s business reflect the importance and value of the licences and permits (or other intangible assets) being preserved under the RVO structure?

In the matter at hand, the Company and the monitor had demonstrated that the use of an RVO was appropriate in the circumstances as it allowed for the preservation of the Company’s many permits and licenses necessary to conduct its gold mining operations. Conversely, under a traditional asset sale and approval and vesting order structure, the purchaser would have to apply to the various agencies and regulatory authorities for transfer of existing licenses and permits or, if transfers are not possible, for new licenses and permits, which would necessarily involve risk, delays and additional costs.

The Court also commented on its jurisdiction to cancel all outstanding shares and the issuance of new shares to the purchaser as part of the RVO, finding it had jurisdiction under subsections 186(1) and 186(2) of Ontario Business Corporations Act (the “OBCA”) which provides that if a corporation is subject to a “reorganization”, its articles may be amended by a court order to effect any change that might lawfully be made by an amendment under section 168 of the OBCA including to change the designation of all or any of its shares, and add, change or remove any rights, privileges, restrictions and conditions in respect of all or any of its shares. We note that the Canada Business Corporations Act has similar provisions and courts presumably have jurisdiction to grant similar relief under that statute and other provincial corporate statutes with similar provisions.

Finally, the Court also granted, as part of the RVO, broad releases in favour of the Company’s present and former directors, officers, employees, and advisors, as well as the monitor and the purchaser and their respective present and former directors, officers, employees and advisors on the basis of the criteria set out in Re Lydian International Limited^[7], which are:

1. whether the claims to be released are rationally connected to the purpose of the restructuring;
2. whether the releasees contributed to the restructuring;
3. whether the release sought is fair, reasonable and not overly broad;
4. whether the restructuring could succeed without the release sought;
5. whether the release sought benefits the Company as well as its creditors generally; and
6. the creditors’ knowledge of the nature and effect of the release sought.

Key Take-Aways

The decision in Re Harte Gold Corp. will likely become a leading authority for courts when evaluating RVOs. It suggests a debtor company will be subject to a two-step test that will involve: first, evaluating whether the contemplated sale should be approved taking into consideration the applicable statutory criteria, and second, evaluating whether it is appropriate in the circumstances for the sale to be implemented through a reverse vesting structure given the specific facts of the case. This will likely lead to additional scrutiny on the use of RVOs going forward. Parties will need to be prepared to justify why a RVO structure is necessary or appropriate for completing a value-maximizing transaction (in comparison to a traditional approval and vesting order). Despite such additional scrutiny from the Court, we expect that RVOs will remain nonetheless a powerful tool in complex restructurings which will allow for the completion of going concern sale transactions in industries where assets and licenses may be difficult to transfer such as the cannabis and mining industries.

[1] Re Harte Gold Corp., 2022 ONSC 653.

[2] Stikeman Elliott LLP acted for Harte Gold Corp. in connection with its proceedings under the CCAA.

[3] Re Quest University Canada, 2020 BCSC 1883 [Quest] (leave for appeal dismissed, Southern Star Developments Ltd. v. Quest University Canada, 2020 BCCA 364).

[4] Arrangement relatif à Nemaska Lithium Inc, 2020 QCCS 3218 (leave to appeal refused, Arrangement relatif à Nemaska Lithium Inc, 2020 QCCA 1488; leave to appeal to SCC refused, Arrangement relatif à Nemaska Lithium Inc, 2021 CanLII 34999).

[5] Quest, supra note 3.

[6] As stated in the Supreme Court of Canada’s decision in 9354-9186 Québec inc. v. Callidus Capital Corp. 2020 SCC 10, the Court’s discretion under section 11 of the CCAA must be exercised in furtherance of 3 baseline considerations: (a) the order sought must be appropriate in the circumstances, (b) the applicant must have acted in good faith and (c) with due diligence.

[7] Re Lydian International Limited, 2020 ONSC 4006.

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