Approval of third-party releases under the CCAA: the court lowers the bar in Aquadis

A monitor appointed under the Companies’ Creditors Arrangement Act (CCAA) can sue third parties in the name of the debtor to maximize the debtor’s assets for its creditors.

If the monitor settles a claim with some of the defendants, they will usually insist on a full and complete court-approved release. Courts will generally approve the release if it is fair and reasonable in the circumstances and if the rights of the non-settling defendants are protected.

Summary

A recent decision has significantly lowered the standard for approving a third party release. In the matter of Arrangement relatif à 9323-7055 Québec inc. (Aquadis International Inc.), 2018 QCCS 2945 (leave to appeal to the CA refused, hereinafter “Aquadis”), the court approved a settlement agreement (i) granting release to defendants who did not contribute to the settlement, (ii) offering no procedural protection to the non-settling parties, and (iii) offering very limited protection to the substantive rights of the non-settling parties.

The factual context

The debtor 9323-7055 Québec inc. (formerly Aquadis International Inc.) was a wholesale seller of plumbing fixtures. It suffered financial difficulties when hundreds of defective faucets it had sold failed, causing damage to property owners whose insurers ultimately filed subrogated claims against Aquadis. Those claims amounted to nearly $Cdn 22 million and the monitor estimated potential future claims at an additional $Cdn 25 million.

The monitor began proceedings against the manufacturer and the distributor of the faucets and their insurers. The court also authorised the monitor to file proceedings against the retailers who had sold the faucets, not in the name of the insolvent debtor (which had no right of action against the retailers), but in the name of the debtor’s creditors (i.e., the property insurers that had filed subrogated claims against Aquadis).

The monitor received offers of settlement from the manufacturer and the distributor’s insurers. The monitor sought court approval of the offers. The retailers opposed approval on the grounds the manufacturer and the distributor were being released even though they were not contributing financially to the settlement.

The retailers also argued the terms of the offers may infringe their rights to file contribution claims against the manufacturer and the distributor. To defeat that argument, the offers were amended so that the retailers’ potential liability would be reduced by any sum the retailers could prove would have been recoverable from the manufacturer or the distributor had the settlement not been entered into.

The decision

The court rejected the retailers’ arguments and approved the settlement offers, noting the offers were the result of a fair process and in the best interest of the creditors. The fact the manufacturer and the distributor were being granted releases although they did not financially contribute to the settlement (only their insurers contributed to the settlements) was not considered sufficiently important to deprive the creditors of the benefit of the settlement amounts.

The court also held that the comfort clause, although not perfect, was valid in the circumstances since it was consistent with article 1531 of the Civil Code of Quebec (CCQ) and with similar provisions in Pierringer-type agreements which essentially allow one or more defendants in a multi-party action to settle with the plaintiff and withdraw from the litigation leaving the remaining non-settling defendants responsible only for the loss they actually caused. Article 1531 CCQ provides:

“Where, through the act or omission of the creditor, a solidary debtor is deprived of a security or of a right which he could have set up by subrogation, he is released to the extent of the value of the security or right of which he is deprived.”

The court reached that conclusion even though the comfort clause was problematic for potential future claims and that, contrary to the situation usually prevailing in Pierringer-type agreements, the liability between the various defendants was not joint and several in the circumstances. The court did not even consider that the offers provided no protection for the retailers’ procedural rights.

Takeaway

The decision in Aquadis shows courts may be willing to lower the bar for approval of settlement offers providing for third-party releases. If a court finds the settlement offer is beneficial to the creditors and to the restructuring or liquidation of the debtor, the criteria that have been reiterated by the leading case law may be applied with more flexibility and with less concern for the rights of third parties.

The impact of Aquadis is difficult to predict. Although leave to appeal of the first instance judgment was refused by the Court of Appeal because the settlements had been executed by the time it heard the case, the Court of Appeal felt the need to add that “[…] the effect of global releases arising from partial (as opposed to global) settlements has not been entertained by this Court and the jurisprudence in the rest of Canada is not, arguably a closed book.” It will be interesting to see whether Canadian courts will follow Aquadis or whether they will adhere to the more stringent conditions developed by previous case law.