Cross-Border Guarantees

The issue of the appropriateness of Canadian subsidiaries guaranteeing obligations of affiliated U.S. entities in insolvency situations has recently received significant comment in the Ontario Superior Court of Justice. In particular, the situation where proposed DIP financing has been conditional on a guarantee by a Canadian debtor of U.S. debtors' obligations has been considered in Re A & M Cookie Co. Canada¹, Re InterTAN Canada Ltd.², Re Smurfit-Stone Container Inc.³, and most recently in Re Indalex Ltd.⁴

Generally, the issue that has been causing concern for the Canadian Courts is when the Canadian debtor agrees to guarantee obligations of an affiliated U.S. entity such that if there was a shortfall on the realization of U.S. assets, the assets of the Canadian debtor would not be available to the current creditors of the Canadian debtor.

In such circumstances, if the DIP facility results in a substantial change to the status quo, the Courts have noted that if the Canadian debtor's assets are going to be used as a basis for obtaining finance for a related entity, then Canadian debtors and secured lenders requesting such extreme relief on an initial application, with little or no notice, must establish the evidentiary basis for the requested relief. Of particular assistance to the Court is having a proposed monitor report on the requested DIP financing and prepare an analysis of the impact on Canadian creditors of any guarantee of obligations of foreign borrowers.

The Court has established certain factors to be considered in determining the appropriateness of authorizing a guarantee in connection with a DIP facility:

1. the need for additional financing by the Canadian debtor to support a going concern restructuring;
   
2. the benefit of the breathing space afforded by CCAA protection;
   
3. the availability (or lack thereof) of any financing alternatives, including the availability of alternative terms to those proposed by the DIP lender;
   
4. the practicality of establishing a stand-alone solution for the Canadian debtors;
   
5. the contingent nature of the liability of the proposed guarantee and the likelihood that it will be called on;
   
6. any potential prejudice to the creditors of the entity if the request is approved, including whether unsecured creditors are put in any worse position by the provision of a cross-guarantee of a foreign affiliate than as existed prior to the filing, apart from the impact of the super-priority status of new advances to the debtor under the DIP financing;
   
7. the benefits that may accrue to the stakeholders if the request is approved and the prejudice to those stakeholders if the request is denied; and
   
8. a balancing of the benefits accruing to stakeholders generally against any potential prejudice to creditors.⁵
   

On balance, the Courts have found that the potential upside of a going concern operation with the preservation of jobs and the benefits of continued operations for other stakeholders was preferable to a liquidation, notwithstanding that provisions of the DIP facility effectively transferred assets from the debtor to another member of the enterprise group. However, the analysis and support from a proposed monitor is likely required, and certain safeguards (such as a super-priority charge for unsecured creditors' claims⁶) may be required to further convince the Court that the DIP financing agreement and guarantee are warranted.

Footnotes

^{1.49 C.B.R. (5th) 188, 2008 CarswellOnt 7136 (Ont. S.C.J. [Commercial List])}

^{2.2008 CarswellOnt 8040, 49 C.B.R. (5th) 248 (Ont. S.C.J. [Commercial List]) and 2009 CarswellOnt 324 (Ont. S.C.J. [Commercial List])}

^{3.2009 CarswellOnt 391, 50 C.B.R. (5th) 71 (Ont. S.C.J. [Commercial List])}

^{4.2009 CarswellOnt 1998 (Ont. S.C.J. [Commercial List])}

^{5.Re Indalex Ltd., supra, at para. 8}

^{6.Re InterTAN Canada Ltd., supra}

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.