CCAA Court's jurisdiction to suspend contractual restrictive covenants in the context of a sale process

Introduction

It has long been recognized that under Canada’s Companies’ Creditors Arrangement Act (CCAA), supervising courts have the discretion to set aside restrictive covenants in connection with the court’s approval of a sale of assets or other M&A transactions in a CCAA case. Less certain was whether such restrictive covenants could be effectively set aside at the outset of a Sale and Investment Solicitation Process (SISP). In a case of first impression, the Superior Court of Québec has taken this step—staying the exercise and effect of restrictive covenants at the launch of a SISP.

The Canadian Supreme Court decisions in Canada North and Callidus remind us that the most important feature of the CCAA is the broad discretionary power it vests in the supervising court. Indeed, Section 11 of the CCAA provides the supervising court with the jurisdiction to “make any order that it considers appropriate in the circumstances,” limited only by the restrictions set within the CCAA and by the requirement that the order made be appropriate to the case.

In Canadian jurisprudence, the discretionary power of the supervising court to stay contractual rights of third parties can be traced back to the 1988 decision of Norcen. In this formative decision, the Alberta Court of King’s Bench ruled that “s. 11 of the CCAA can validly be used to interfere with some other contractual relationships in circumstances which threaten a company’s existence… such interference in the interest of fairness to all parties should be effective only for a relatively short period of time.”¹ The Norcen case prompted a series of decisions which have since recognized the powers of the supervising court to interfere with third party contractual rights under the CCAA.

Subsequent case law has further expanded the court’s discretion. In Protiva, the Court of Appeal for British Columbia held that the discretion to interfere with third party contractual rights must be exercised according to fairness and must balance competing stakeholder interests by taking into account the extent of the adverse impact as well as the beneficial effects upon the company and its stakeholders.² Furthermore, the Court ruled that it is not necessary that a proponent of an arrangement be in extremis or otherwise show a public interest justification before third party contractual rights can be affected.³

Thus, the CCAA courts have the necessary power to approve transactions without complying with restrictive covenants, in exceptional circumstances where the equities and the best interests of the debtors’ stakeholders in general favour such an order. In the matters of Bear Hills and Quest, the Courts in Saskatchewan and British Columbia also took into consideration the welfare of the business carried on by the corporations and the necessity to avoid an “economic dislocation which a liquidation or winding up would involve”⁴ in their decisions when vesting off the rights of first refusal.

In the recent Québec Superior Court ruling of Xebec, Justice Immer notes that two different approaches have been used by courts when asked to extinguish third party rights. The first approach is the one taken in Third Eye, where the court must first assess the nature and strength of the interest that is proposed to be extinguished, and then consider whether the parties have consented to the vesting of the interest at some point. In case of ambiguity or inconclusiveness in these factors, the Court then determines the appropriate order with consideration of the equities. The second approach is the one taken in Quest, where the Court uses a balancing of equities to see whom it favours, while taking into account the parties’ conduct, the rights of first refusal terms, the prejudice and the monitor’s opinion. The Quest approach seems to be increasingly used by the courts. In any case, Justice Immer explains that a “SISP is fundamentally incompatible with a right of first refusal.… To recognize such pre-emption rights is completely destructive of the SISP’s aims.”⁵

Similarly, such discretionary power was also recognized in U.S. chapter 11 courts, and in many instances these courts found the restrictive covenants such as rights of first refusal unenforceable because of their “chilling effect” on bids in the context of a SISP, as well as their thwarting of “the fundamental policy of maximizing estate assets for the benefit of all creditors.”⁶ This “chilling effect”, first explained in the case of Re Mr. Grocer, Inc., was further developed in the case of Adelphia, where restrictive covenants were rendered unenforceable at the initiation of the SISP.

Yet, the question always remained open in Canada as to whether the CCAA court had jurisdiction to pre-emptively stay rights of first refusal and other restrictive covenants at the initiation of a SISP. With the Groupe Sélection inc. case, the Superior Court of Québec confirmed for the first time that this broad discretionary power also exists in a Canadian CCAA Court.

Groupe Sélection Inc. decision

The Re Groupe Sélection Inc. case before the Superior Court of Québec began when the Monitor submitted an Application to the Court on March 10, 2023, advising that it was ready to launch the SISP and seeking approval of the sale process and procedures. This SISP approval was challenged by the debtor Groupe Sélection Inc. (GS) and several of GS’s secured creditors and business partners, who held controlling interests primarily in real estate assets and were intent on capitalizing on their minority interests.

Apart from three GS business partners who objected to GS's rights in specific contracts included in the SISP assets, there were no other objections to the overall implementation of the SISP. Instead, the concerns centred around the terms and conditions set by the Monitor, which led to several interventions and objections from the affected stakeholders.

Specifically, GS's business partners contested the marketing of GS's rights in certain contracts with the business partners. Their argument was based on the assertion that these contracts were intuitu personae, and as a result, GS's rights in them could not be sold or transferred to a third party without obtaining approval from the business partners themselves as counterparties. There was also concern that the partners would be forced without consent to accept a new partner replacing GS.

The Québec Superior Court stated that the interventions made by these business partners were hypothetical and premature, as it was uncertain whether these potentially non-transferable contractual rights would be of any interest to a potential buyer. The Court clarified that these partners would have the opportunity to restate their positions and arguments at a later stage of the SISP if the disputed contractual rights indeed became the subject of a binding letter of intent from a potential purchaser. Therefore, if a binding offer was to be received that would violate the restrictive covenants, the Court would allow the contesting parties to challenge the legality of any resulting transaction.

The Court concluded that at this stage, the purpose of the SISP is to monetize GS’s assets, but also to assess the market interest in these assets and determine their market value. The Court ordered and declared that the contractual rights and remedies of third parties restricting the disposal of assets and/or any part of the Debtors’ business, including the restrictive covenants (rights of first refusal, rights of first offer, rights to match an offer, options purchase or others) are stayed and unenforceable in the context of the SISP.

Takeaway

Whereas similar orders were previously rendered at the stage of sale approval in rulings such as Quest and Norcen, the Groupe Sélection decision appears to be the first ruling of a Canadian court to suspend restrictive covenants upon the initiation of a SISP. In the Superior Court’s reasoning, the financial survival of the company and the legal chaos that would ensue from the liquidation of the company because of its complex situation were considerations that were taken into account. In general, Canadian courts look into the following non-exhaustive factors, which when met, militate in favour of the Court setting aside restrictive covenants:

1. A bundle of assets are sold together instead of individually;
2. There is evidence that a sale without restrictive covenants would generate greater recoveries, would maximize value for the stakeholders and that the transaction is in the best interests of the creditors at large;
3. Restrictive Sale Provisions would have a chilling effect on the SISP;
4. The interest of the beneficiaries of the restrictive covenants is taken into account and the beneficiaries do not suffer material prejudice.

Maximization of the debtors’ assets is one of the overarching purposes of modern CCAA restructurings. It follows that Canadian courts will not hesitate to defend an open and transparent SISP where participants are encouraged and protected to perform their due diligence and submit their bids. This includes, in appropriate circumstances, staying restrictive sale provisions which may be used to thwart or delay the SISP.

The author gratefully acknowledges the assistance of Nima Shareghi, a student at law in the firm’s Montréal office, for his assistance in preparing this article.