A. Interim Financing

Author:Roderick J. Wood
Profession:Faculty of Law. University of Alberta

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Restructuring law imposes a stay of proceedings on the actions and remedies of the creditors. It does so in order to give the debtor an opportunity to develop a plan to put before the creditors for their approval. During this interim period, the debtor will continue to carry on business. However, a dramatic change occurs when restructuring proceedings are commenced. Suppliers of goods and services may no longer be prepared to extend credit to the insolvent firm. Significant administrative costs are incurred in a restructuring, and insolvency professionals will not be prepared to provide their services unless payment of their fees is assured. The restructuring plan may involve a downsizing in which only the more profitable portions of the business are retained. It may be necessary to reduce the workforce, break leases, and terminate other contractual arrangements. Restructuring law provides a number of devices to address these and other difficulties that arise during this interim period.

1) The Position of Post-Filing Creditors

There is a fundamental difference between creditors who extend credit prior to the commencement of the restructuring proceedings (pre-filing creditors) and those who extend credit after its commencement (post-

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filing creditors). The claims of pre-filing creditors are subject to the plan,1and these creditors are given an opportunity to vote to accept it or reject it.2If the plan is accepted, their claims will be compromised or otherwise affected in the manner specified in the plan. The post-filing creditors are not affected by the plan. In the event that the restructuring is successful, their claims will be fully enforceable against the debtor. Claimants who have entered into pre-filing contracts that are later disclaimed by the debtor after the commencement of restructuring proceedings are treated as pre-filing creditors in respect of their damages claims against the debtor for breach of contract.3

This does not mean that post-filing creditors should blithely extend credit to the debtor without a worry or care. The fact remains that the debtor is insolvent and the success of the restructuring is by no means assured. If the restructuring fails, the post-filing creditors will be in the same position as the pre-filing creditors.4They will share pari passu with all the other unsecured creditors after the secured creditors have withdrawn their collateral or its value from the pot of realizable assets. For this reason, post-filing creditors are often unwilling to grant credit to the debtor. The post-filing creditor has four options in this situation:

(1) refuse to supply the goods or services; (2) supply the goods and services on a cash-on-delivery basis; (3) negotiate a post-filing trade creditor’s charge on the debtor’s assets to secure the payment obligation; or (4) take the risk of supplying goods or services on credit.5Some of the earlier orders granted under the CCAA required post-filing creditors to continue to supply goods or services to the debtor while restructuring proceedings were under way.6The legislation was subsequently amended to make it clear that a creditor could not be

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compelled to do so.7Both the CCAA and the BIA now provide that a post-filing creditor is not prevented from requiring immediate payment for goods, services, use of leased property, or other valuable consideration, and neither statute requires a creditor to make a further advance of money or credit.8The supplier may exercise this right even if the agreement provides a later date for payment.9A debtor who is contemplating restructuring proceedings must therefore devise a strategy to ensure that it will be able to operate the business and pay post-filing obligations during the restructuring proceedings. A failure by the debtor to put into place some means of financing the operations of the business during the restructuring proceedings may result in the termination of the proceedings by a court.10Once restructuring proceedings are commenced, the debtor will suspend any further payment to the pre-filing creditors.11The claims of these creditors will be compromised or otherwise affected in the manner specified in the plan. The suspension of these payments is sometimes sufficient to free up sufficient cash flow to pay the post-filing creditors and the insolvency professionals. However, often it is not enough, and the debtor must search out some other source of financing for these expenses.

2) DIP Financing

The term "debtor-in-possession" (DIP) financing is used to describe the interim financing required for the ongoing operations of the business during restructuring proceedings. The term originates in the United States and is used in American bankruptcy law to describe a debtor who remains in possession of the property under Chapter 11 restructuring proceedings. Although Canadian insolvency law does not make use of this legal concept, the term is now widely used in reference to interim financing.

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a) Judicial Development

Neither the CCAA nor the BIA originally addressed the issue of DIP financing. The gap was filled by the courts, which began to exercise their inherent jurisdiction or equitable jurisdiction to grant orders authorizing the debtor to obtain interim financing. The courts also began to grant charges against the assets of the debtor to secure the interim financing. At first, these orders simply gave the interim lender priority over existing unsecured creditors.12However, this was not sufficient to induce an interim lender to advance funds to an insolvent debtor who had given a security interest in all of its present and future assets to an earlier lender. Courts then began to make orders that gave the charge priority over existing secured creditors.13When this type of order is made, the DIP charge is said to prime the other secured loans. Some courts have taken the view that they can also give the DIP charge priority over statutory liens,14while others have held that they are unable to do so.15Courts have also made orders creating a superpriority for a DIP lender under the BIA on the basis of their inherent jurisdiction.16Although notice to secured creditors affected by the order was viewed as desirable, it was not strictly insisted upon where the application was made on an urgent and interim basis.17As the availability of a comeback provision provided only a limited check on overreaching orders, courts took the position that the initial order should be limited to terms that are reasonably necessary for a brief time on an urgency basis.18The initial order should give the debtor the ability to "keep the lights on" and more extensive provisions should be introduced in the subsequent order when all interested parties have been notified and given the opportunity to consider their positions. The priority afforded to the DIP lender was also extended to amounts advanced prior to the making of the initial order so long as it was connected to the restructuring proceedings.19Courts attempted to contain the potential prejudicial effect of DIP financing orders by placing a monetary cap on the amount secured by the charge.

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In determining whether it is appropriate to give a DIP lender priority over existing secured creditors, courts considered the extent to which the secured creditors would be adversely affected. They indicated that there should be "cogent evidence that the benefit of DIP financing clearly outweighs the potential prejudice to the lenders whose security is being subordinated."20To make this assessment, the court must be given information as to the value of the collateral and the amount of the secured obligations.

In some cases, the DIP lender is a new lender that has had no past dealings with the debtor. In other cases, the DIP loan is obtained from an existing creditor. A pre-filing lender may extend funds to the debtor in order to enhance its recovery on its pre-filing claim or to gain a greater ability to influence the direction of the restructuring. Under certain circumstances, courts have been willing to extend the scope of the DIP charge so that it covers pre-existing obligations that are unconnected to the DIP loan. In the Air Canada restructuring, a DIP lender was given a charge on the debtor’s assets to secure a US$700 million DIP loan as well as to secure any shortfall in respect of twenty-two aircraft that had been previously leased by the lender to Air Canada.21This gave the DIP lender priority over the other unsecured lender in respect of its...

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