Key legal and regulatory developments driving and shaping M&A
The CCAA proceedings of Stornoway demonstrate an innovative use of the CCAA sale process as an alternative to plans of arrangement where there is no value remaining beyond the realization of secured debt and the parties intend to maintain the going concern operations of the debtor company. The Stornoway case provides further judicial recognition of the notion that when there is no value beyond the senior creditors' debt, the CCAA's purpose and objective may be achieved by facilitating the enforcement of secured rights and the effective discharge of certain junior debts, so long as the transaction is aimed at preserving a business's going concern operations.
On September 8, 2019, as a result of its insolvency, Stornoway Diamond Corporation and a certain number of its subsidiaries ("Stornoway") filed an initial motion seeking creditor-protection pursuant to Canada's Companies Creditors' Arrangement Act (the "CCAA").
Stornoway is a Canadian mining corporation, which was listed on the TSX prior to the CCAA proceedings and employs 540 employees. Its main operation is centered around the Renard Mine (one of only four diamond mines in Canada and a flagship component of Québec's Plan Nord).
Construction at the Renard Mine commenced on July 10, 2014, following the successful completion of a comprehensive CAD$946 million financing package designed to fully fund the project to completion. The Renard Mine financing was the largest single project financing transaction for a publicly listed diamond company in Canada, and included equity, senior and convertible debt, equipment financing and the world's first ever diamond stream financing, in which a streaming company makes an upfront payment to a diamond company in return for the right to purchase a fixed percentage of future production of diamonds produced by a project, and makes on-going payments for each unit delivered under the streaming agreement.
An unfortunate storm of challenges hit the mine at the outset. During the first two years of operation, diamond production fell short of projections due to delayed underground mine ramp-up (attributable to unexpected rock conditions) coupled with lower-grade ore in the initial extractions and higher than anticipated levels of diamond breakage. On top of the operational problems, the second half of 2018 also saw a rough diamond market price correction. This market decline was partly attributed to happenings in India, where rough diamonds are made into finished products. The Indian diamond industry suffered due to the weakening Indian Rupee, the lack of available credit available to Indian diamantaires, excess of polished inventory in India and lower margins in manufacturing. At the time of its financing, the projected average price for the Renard Mine diamonds was set at US$147/ct. The average pricing achieved in the second quarter of 2019 was only US$76/ct, with a continued downward trend.
In light of its financial difficulties, in June of 2019, Stornoway, with the assistance of its financial advisors and with the support of and financing from its principal secured lenders (the "Secured Creditors"), initiated and conducted a sale and investment solicitation process .
On July 15, 2019, a single third-party bidder submitted an offer for the acquisition of Stornoway's assets, which bid was for an aggregate consideration significantly less than the aggregate secured indebtedness owing to the Secured Creditors. After careful review, Stornoway and the Secured Creditors came to the conclusion that the bid was not satisfactory in the circumstances.
Since the sale procedures clearly and expressly foresaw the right of the Secured Creditors to submit a credit bid up to the amount of their secured indebtedness, the parties began negotiating the potential terms and conditions upon which a credit bid could be implemented from a transactional standpoint. On September 8, 2019, these discussions ultimately led to the execution of a letter of intent between Stornoway and the Secured Creditors (the "LOI").
On September 9, 2019, the Superior Court of Quebec (Commercial Division) (the "Court") granted the Initial motion in the CCAA proceedings, which was sought in order to implement the LOI. At that point, Stornoway's accumulated deficit amounted to approximately CAD$660 million. As at August 31, 2019, the estimated outstanding liabilities of Stornoway, excluding contingent liabilities, amounted, on a consolidated basis, to approximately CAD$715 million.
As part of the Initial Order, the Court also granted various other relief in favour of Stornoway, including the authorization for Stornoway and its subsidiaries to enter into a working capital facility with its Secured Creditors, giving them access to an additional CAD$20 million in liquidity, which could be increased to up to CAD$50 million, in order to provide a runway to complete the sale in the CCAA proceedings.
On October 4, 2019, a Share Purchase Agreement (hereinafter referred to as the "SPA") was entered into, whereby the Secured Creditors agreed to acquire by credit-bid, through a newly formed entity, substantially all of the business of Stornoway. The SPA was approved by the Court on October 7, 2019 through the issuance of an Approval and Vesting Order. The SPA preserved and assumed, inter alia, all obligations of Stornoway towards its trade suppliers (including pre-filing obligations) and the near totality of its employees.
There were significant liabilities, however, that were not assumed by the Secured Creditors in connection with the credit-bid transaction. These non-assumed liabilities were transferred, assigned and vested in newly incorporated non-operating companies as part of a pre-closing reorganization. The Monitor's powers were then expanded so as to enable it to assign the new companies into bankruptcy under the Bankruptcy and Insolvency Act.
This type of transaction would have typically taken the form of a secured creditor plan of arrangement where the plan offered nothing to unsecured creditors. The plan route would involve additional Court process and a longer timeline to achieve the goal. Instead, it was decided to take a sale path through the use of what can more appropriately be called a "Reverse Vesting Order" in which the non-assumed liabilities (and certain other assets) were extracted from the business by virtue of the Court's order.
By vesting out its unwanted assets/liabilities, the business of Stornoway emerged from CCAA proceedings swiftly while preserving its going concern operations and the tax attributes in relation thereto. Additionally, the vesting order allowed for an effective change of control. Another one of the particularities was that the vesting order granted broad releases in favour of third parties, notably the directors and officers of Stornoway and the purchaser who played a key role in the reorganization.
Such transactions are permitted under the CCAA, which is remedial legislation designed to enable insolvent companies to restructure, particularly where such transactions are to permit an internal reorganization that is fair to the interests of affected stakeholders and there is no prejudice to the Applicants' major creditors. The Court relied on precedents which had recognized that the transfer of liabilities out of the insolvent debtor may be effected when it (a) facilitates the restructuring of the debtor company into a competitive industry participant, (b) preserves the going concern value for stakeholders, (c) preserves the employment of many employees, (d) was extensively negotiated amongst stakeholders with significant interests, and (e) did not prejudice the major creditors of the debtor company.
The transaction approved by the Court for Stornoway demonstrates the flexibility that CCAA proceedings offer for distressed M&A transactions and secured creditor realization. The structure enabled a quick disposition to the secured parties and the continuation of the business as a going concern outside of the usual lengthy plan of arrangement process. Secured lenders to Canadian companies should take note of this case, which provides lenders with a tool for an efficient acquisition of a distressed business, while maintaining tax attributes and isolating unwanted liabilities.
Arad Mojtahedi is an associate in our Montreal office in the firm's dispute resolution and litigation group.
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