Secured lenders to Canadian corporations have long taken the risk that their security interests in the borrower’s inventory and accounts will be subordinated to deemed trust claimants under section 57(4) of the Pension Benefit Act (Ontario) (“PBA”). But the recent decision by the Supreme Court of Canada in Re Indalex increases this risk substantially by expanding the scope of the deemed trust to include not only current- service plan contributions that are due and payable but also any funding deficiencies that crystallise on the wind-up of the plan. [1]
Existing secured lenders may now find themselves at risk of being subordinated to a large pension deficiency if a wind-up were to occur. And given the fact that it is impossible to precisely quantify the deficiency until the plan winds up, new or prospective lenders may find it difficult to assess and price the risk.
What can be done to deal with the increased risk?
Assess the risk
Lenders will want to review their current portfolios to assess what percentage of credit has already been extended to companies with defined benefit pension plans and what future credit, if any, should be extended.
Prospective lenders will have to review and revise their due diligence process to include a detailed review of the pension plan, its current funded status on a solvency basis, the reasonableness of the assumptions that underlie the plan and the company’s future abilities to fund the plan in good times and bad. Past actuarial valuations should be reviewed and updated, if possible.
Increase the return on the loan
Lenders may need to offset some of the uncertainty resulting from the Indalex decision by increasing the return on the loan through increased fees and interest rates.
Control and monitor the borrower’s behaviour
Loan documents will need specific pension-related provisions. For example, negative borrower covenants could prohibit plan amendments that increase the employer liability under the plan, wind up defined benefit pension plans or create new plans without the prior written consent of the lender. Positive covenants could require the borrower to inform the lender of any defaults in a borrower’s defined benefit pension plan and of any notices from regulators which could lead to the wind-up of the plan. Events of default should include any steps taken by the employer or regulator to wind up the plan, and remedies upon an event of default should allow the lender to appoint a new pension plan sponsor and administrator.
In addition to the usual financial reporting, borrowers should be required to provide lenders with pension-related reporting, including updates of actuarial valuations.
A lender that obtains a board seat or observer status will need to review information presented at meetings to monitor the pension plan situation. Officers’ certificates can be requested on a regular basis confirming that the borrower has made pension plan payments in accordance with the most recent actuarial valuation report and that, to the best of their knowledge, no deficiency liabilities exist.
Obtain additional security
A prospective lender will have to consider other potential sources of recovery, such as additional collateral from the borrower and secured guarantees from third parties. Where possible, a prospective lender should lend to a company only where the value of the collateral without accounts and inventory more than adequately secures the credit facility.
Negotiate concessions from pension plan beneficiaries and unions
As its price for supporting a restructuring under the Companies’ Creditors Arrangement Act (“CCAA”), a lender may be in a good position to negotiate an arrangement with the borrower, union and pension beneficiaries which eliminates, reduces or caps a wind-up deficiency and/or subordinates the deemed trust.
In a bankruptcy/liquidation the PBA deemed trust is defeated and will rank behind secured creditors. Hence, one option for existing lenders will be to seek to issue a bankruptcy application in the appropriate circumstances. This may be a bargaining chip to encourage pensioners, unions and the borrower to agree to concessions to the secured lander.
DIP lenders are protected
The Indalex decision is not all bad news for secured lenders. The decision confirmed that the doctrine of paramountcy, under which federal legislation prevails over provincial statute to the extent the two conflict, operates as a matter of law. Accordingly, the deemed trust created under the PBA was subordinate to the super-priority charge granted to the debtor-in-possession (“DIP”) lender by the CCAA judge, even though the paramountcy issue was not raised at the initial proceeding.
[1] Sun Indalex Finance, LLC v. United Steelworkers, 2013 SCC 6.
Co-authored by Christopher Besant, Lydia Salvi, and Shaheen Karolia.
