Bankruptcy laws can be strict or loose. Strict jurisdictions impose onerous and long repayment requirements on debtors. Others set debtors free relatively quickly. Too strict, and you stifle entrepreneurship and productive risk-taking. Too loose – or worse, too uncertain – and capital becomes harder to borrow, with the same bad economic outcome.
Setting bankruptcy law and policy is a legislature's job. And when conflicts and uncertainty arise, such as between federal bankruptcy law and provincial pension law, figuring out how a legislature might have intended to resolve them is the court's job.
That's what makes the Supreme Court of Canada's Sun Indalex Finance LLC v United Steelworkers decision, released last Friday, an important result. It's a clear and thoughtful decision, too.
There's no question that Indalex's impact will be a blow to jilted pensioners. Indalex Ltd., a U.S.-Canadian aluminum company, went bust in the face of a commodity price squeeze and collapsing demand in the 2009 recession. The Canadian unit filed for protection under our bankruptcy law, the Companies' Creditors Arrangement Act (CCAA). And, when it did so, two underfunded defined-benefit pension plans sponsored and managed by Indalex, and the pensions' beneficiaries, found themselves in creditor limbo.
Why? Ontario's Pension Benefits Act makes clear, or tries to make clear, that pension obligations stand at the head of the creditor priority list when businesses go bust, and not everyone will be made whole. But in the CCAA proceeding, Indalex's U.S. parent had guaranteed the Canadian company's debtor-in-possession (DIP) financing – money that enabled the business to continue operating. And, when a court order is granted under federal CCAA, secured financing such as DIP jumps to the head of the creditor list. After all, if this risky debt didn't get priority, it would be pretty hard for bankrupt companies to borrow the money that enables work-outs.
And that, of course, is what caused feathers to fly. On learning that their claims were not at the head of the priority list, and would not be paid in full, the pension beneficiaries, including the Steelworkers, sued. At lowest court they lost, and appealed to Ontario's Court of Appeal. There, Justice Eileen Gillese produced an eyebrow-raising decision, ruling that the pension deficiencies represented "deemed and constructive trusts which had priority over the DIP financing priority and over other secured creditors."
It is that fishy decision that the Supreme Court fried last Friday. The Court barely paused over the conflict between federal and provincial law – when the two conflict in the same legislative space, federal law is paramount, and the court order under CCAA had the same effect as statutory priority.
The question of a constructive trust was more difficult. The problem arose because the pensions were managed by Indalex itself: The managers had a duty to the firm, and as pension administrators had fiduciary duties to the beneficiaries, a potential conflict. In the CCAA proceedings, the pensioners did not then have the knowledge or opportunity to defend interests that they might have had, had the plan's administration been independent. That is why the Ontario Court of Appeal said the implied breach of fiduciary duty gave rise to a remedy known as a constructive trust – and the pensioners did, therefore, have a claim on Indalex's assets ahead of the DIP lenders.
The Supreme Court accepted that there was a potential conflict from the outset – but that it made no difference to the outcome. Further, the lower court's remedy, a constructive trust, might have been appropriate had the conflict given rise to a specific property that Indalex gained by way of its breach, but that was simply not the case, according to last week's decision. And good thing – declaring a constructive trust would have rewritten creditor priority on the fly, introducing economically harmful uncertainty.
So the high court quashed the Ontario appeal court's ruling, restoring the advantage of secured creditors.
The Supreme Court wrote that the purpose of bankruptcy proceedings "is not to disadvantage creditors but rather to try to provide a constructive solution for all stakeholders when a company has become insolvent."
And that gem of economic wisdom captures the fine balancing act, and the tradeoffs, that underpin the law and economics of bankruptcy.
Common law, or judge-made law, tends to reach economically sound results. Getting to the right economic result, though, is not necessarily the law's job. And it doesn't always do it. But it is heartening to see when it does so as clearly as in Indalex, an example of common law at its best.
Finn Poschmann is vice-president, research, at the C.D. Howe Institute.