Lenders dealt blow in Supreme Court’s pension decision

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The Supreme Court of Canada's recent pension ruling in the case of Indalex Ltd. should have financial lenders taking a nervous look at companies with big defined-benefit pension plans, lawyers say.

In its split decision last week, the court sided with the lenders who offer last-ditch financing to companies in distress, and turned down a bid by retirees of the insolvent Toronto aluminum company for the firm's last $6.75-million in order to cover a pension plan shortfall.

In overturning a controversial 2011 Ontario Court of Appeal ruling, the Supreme Court said the money should instead go to pay off the last-ditch debtor-in-possession (DIP) loans made to the company after it sought court protection from its creditors in 2009 – loans made on the condition they be paid off before other creditors.

But in a move that some lawyers say radically alters the established rules in insolvencies, the Supreme Court also ruled that a pension plan's entire shortfall, once the plan is wound up, becomes what is called a "deemed trust" and should rank ahead of almost all the rest of a company's secured creditors, except those that a judge has deemed to have the super-priority that DIP lenders always demand.

This part of the decision was cheered by some pension advocates – even though in the case of Indalex it was a hollow victory. With the pensioners of big companies such as Nortel Networks Corp. repeatedly seeing their benefits slashed after their employer's collapse, many have called for reforms to Canada's bankruptcy regime that would see pensioners rank ahead of other creditors.

But insolvency lawyers say this "deemed trust" issue simply creates more headaches for companies with big defined-benefit pension plans and those who lend them money.

This part of the ruling means lenders to thousands of companies with large defined-benefit pension plans just saw themselves pushed back in the line of creditors, behind potentially massive pension shortfalls, said D.J. Miller, an insolvency lawyer with Thornton Grout Finnigan in Toronto.

"All of those lenders that have money advanced right now, thinking they are in first position on inventories and accounts receivable, are sitting behind what can be a deficit that can be in the tens or hundreds of millions of dollars," said Ms. Miller, who acted for the Insolvency Institute of Canada, which intervened in the case before the Supreme Court.

Plans that could be close to being wound up, or plans that have large shortfalls, will attract special attention, she said: "I think all of the lenders right now are doing a very careful assessment of their portfolios to determine what their potential exposure is."

She warned that lenders might require extra guarantees and higher rates from companies with big pension plans. Other creditors might be tempted to push a company right into full-blown bankruptcy, which would nullify the pensioners' new rights.

Elizabeth Brown, a lawyer with Hicks Morley Hamilton Stewart Storie LLP in Toronto, said that while some pensioners might cheer what appeared to be a large silver lining in the Supreme Court's ruling, the decision may cause more headaches for companies struggling with expensive defined-benefit pension plans.

"It frustrates your ability to borrow money and it just carries with it this great big financial impediment. It looks like a short-term win for pensioners, but you have to think about it in the long term," she said.

Mitch Frazer, a pension lawyer with Torys LLP, said some lenders will have companies that want to borrow money go into bankruptcy protection more quickly than before, in order to have a court declare them as the favoured creditor ahead of any pension shortfall.

But he didn't think lending would freeze up over the new priority for pensioners: "If you have people willing to lend money, and you have people looking to borrow money, there is always going to be that business of lending money. ... It will probably just be more expensive."