Key legal and regulatory developments driving and shaping M&A
Insolvency proceedings are often used by debtors to sell assets, or entire going concern businesses, "free and clear" of encumbrances in an efficient and expedited manner to maximize recoveries for both secured and unsecured creditors.
In Canada, similar to other jurisdictions, these sales will generally be entered into on an 'as is, where is' basis, supported by an 'approval and vesting order' directing that the transfer will be free and clear of encumbrances. Those encumbrances are then preserved, in accordance with their relative priorities, as against the proceeds from the sale transaction.
The breadth of interests that can be extinguished or 'vested out' through an approval and vesting order has been the subject of some uncertainty in Canadian insolvencies. Purchasers and sellers will of course want these orders to be drafted and interpreted very broadly. Holders of interests in the property being sold may have an incentive in certain circumstances to argue that their specific interest cannot be extinguished or vested out and must follow the asset.
This is not an easy issue to resolve. On one end of the spectrum are financial claims, such as security interests, that are regularly vested out without controversy. The security interest then effectively attaches to the proceeds of the sale. On the other end of the spectrum would be a third-party's clear ownership interest, such as fee simple ownership interest in land, which an approval and vesting order in Canada generally will not extinguish. In other words, an approval and vesting order cannot grant a debtor company the right to sell a third party's property for the benefit of the debtor company's creditors.
Between these two ends of the spectrum are the more difficult cases in the so-called grey area of the law, such as mining royalty interests that may be characterized as an interest in land rather than a financial interest. The treatment of these types of interests under approval and vesting orders in Canada has been inconsistent, which creates some uncertainty in the distressed M&A market.
But recently, the Ontario Court of Appeal has sought to add some clarity to this issue in Third Eye Capital Corporation v. Dianor Resources Inc. The Court of Appeal's decision provides a framework within which parties including debtors, secured lenders and purchasers may consider the appropriate scope of an approval and vesting order that can be applied to a broad range of interests.
Dianor Resources Inc. ("Dianor") was an insolvent exploration company focused on the acquisition and exploitation of mining properties in Canada. Dianor's secured lender, Third Eye Capital Corporation (the "Lender") successfully applied for the appointment of a receiver over Dianor's assets, including its flagship project in Ontario. The project was the subject of royalty agreements in favour of two parties and notices of these agreements were registered on title to the project. The royalties were not generating cash flow for the royalty holders at the time of the receivership.
The lower court approved a sale process that generated two bids for the project. The winning bid from the Lender was a credit bid worth C$2 million, plus the assumption of certain liabilities. The purchase was conditional upon the extinguishment of the royalty interests for which the Lender would pay C$400,000 in aggregate. The royalty interests were to be extinguished pursuant to an approval and vesting order.
The sale was approved by the Ontario court and an approval and vesting order was granted transferring Dianor's interest in the project to the purchaser free and clear of, among other things, the royalties. The transaction closed shortly thereafter.
One of the royalty holders appealed the approval and vesting order, though it did not move for a stay of the approval and vesting order prior to the closing of the transaction and its appeal was commenced after the applicable statutory appeal period expired. Despite the procedural and mootness issues, the Ontario Court of Appeal nonetheless went on to consider and provide an opinion on the substantive matters at issue in the appeal.
The Court of Appeal was asked to consider whether the royalty interests in the applicable project in this case could and should be extinguished pursuant to an approval and vesting order.
The court concluded that it had jurisdiction to extinguish or vest out interests in land. However, when considering whether that jurisdiction should be exercised, the court concluded that a rigorous 'cascade analysis' should be adopted.
First, the court should assess the nature and strength of the interest that is proposed to be extinguished. Not all interests in land share the same characteristics. For example, third-party fee simple interests or an easement in active use generally should not be extinguished through an approval and vesting order. On the other hand, security interests securing loan obligations, are and can be regularly extinguished through an approval and vesting order. The key inquiry is whether the interest is more akin to a fixed monetary interest that is attached to real or personal property or whether the interest is more akin to a fee simple interest that is in substance an ownership interest that is tied to the inherent characteristics of the property itself and that is of a continuing nature.
Second, the court should consider whether the parties have consented to the vesting out of the interest either at the time of the sale before the court, or through prior agreement.
Third, if the above factors are inconclusive, the court may then engage in a consideration of the equities as between the parties to determine if an approval and vesting order is appropriate in the particular circumstances of the case. This would include consideration of the relative prejudice to the interested parties and whether that prejudice could be adequately compensated for through a monetary payment.
Applying these considerations, the Court of Appeal found that the royalty interests in this case did not simply secure a fixed finite monetary obligation, rather they were in substance an interest in a continuing and inherent feature of the property itself. This, in absence of any agreement by the royalty holder to the subordination or extinguishment of its interest, was determinative. Therefore, the royalty rights should not have been extinguished by the approval and vesting order.
Due to procedural issues related to the appeal in this case, the approval and vesting order from which the royalty holder appealed was not reversed. However, the court's substantive analysis will remain relevant for future cases.
The Dianor Resources Inc. decision certainly will be welcomed by holders of mining and other resource royalties for the additional clarity it provides for the protection of their rights in an insolvency scenario.
The decision will also be very important to financial institutions and other parties who may provide secured financing to mining and other resource projects. In a default scenario, these lenders may need to rely on an approval and vesting order to monetize collateral for maximum proceeds. Secured lenders should diligently review any royalty or other interests that may affect the projects that are financed, as those lenders may not be able to simply rely upon an approval and vesting order to resolve these adverse interests in the future. Lenders would also be advised to seek to negotiate contractual arrangements with royalty holders or other interest holders at the outset of the loan to ensure that the parties' respective interests are clearly agreed in advance of any potential future sale that may be required as part of an enforcement or insolvency sale process.
In cases where secured loans and royalty interests already co-exist on a particular mining or resource project, the decision in Dianor Resources Inc. will add clarity to the relative rights and negotiating positions of the parties in the case of any eventual insolvency related to the project.
The decision in Dianor Resources, Inc. provides clear support for the proposition that, in the circumstances of that case, a vesting order may not properly extinguish or vest out mining royalty interests and other similar interests in land. The analysis theoretically could apply to many other types of interests as well. That said, whether and the extent to which the Dianor Resources Inc. decision is applied in all jurisdictions in Canada or to interests other than royalty interests in land, such as purchase options, royalties on personal property, and stream interests, remains to be seen.
Evan Cobb is a partner in our Toronto office in the firm's financial restructuring and insolvency group.
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