International Restructuring NewsWire - October 2020

Authority to bar a creditor from voting and litigation funding as interim financing: The Supreme Court of Canada’s ruling in Bluberi

Global Publication October 2020

We previously reported on a lower court decision in the case of in 9354-9186 Québec inc. v. Callidus Capital Corp., the “Bluberi” decision, approving litigation funding arrangements in the context of a Canadian restructuring proceeding.

The reversal of that decision by the Quebec Court of Appeal created significant questions about the viability of litigation funding in an insolvency case in Canada.

The matter was further appealed to the Supreme Court of Canada.  On May 8, 2020, the Supreme Court of Canada released its written decision and reasoning reversing the Quebec Court of Appeal and reinstating the lower court decision.

The unanimous Supreme Court decision enshrines the recognition of an insolvency court’s wide discretion to, inter alia, approve a litigation funding agreement as interim financing, and to prevent a creditor from voting on a plan for an improper purpose.

Background

Bluberi Gaming Technologies Inc., now 9354‑9186 Québec Inc., (Bluberi) manufactured, distributed, installed, and serviced electronic casino gaming machines. It also provided management systems for gambling operations.

In 2012, Callidus Capital Corporation (Callidus) provided Bluberi with a C$24 million secured loan. Despite missed projections, Callidus continued to extend credit to Bluberi and, by 2015, Bluberi owed approximately C$86 million to Callidus, close to half of which comprised interest and fees.

In 2015, Bluberi filed for protection under Canada’s Companies’ Creditors Arrangement Act (CCAA) and alleged in its filings that Callidus had deliberately employed predatory lending tactics and consumed the equity value of Bluberi with a view of taking over the business. Bluberi’s filing for protection succeeded despite Callidus’ objection. 

In 2016, Bluberi proposed a sale solicitation process, which resulted in four offers, with Callidus submitting the winning offer. Pursuant to the sale agreement, Callidus would obtain all of Bluberi’s assets in exchange for extinguishing almost the entirety of its secured claim against Bluberi, except for an undischarged C$3 million secured claim. Bluberi, on the other hand, was permitted to retain claims for damages against Callidus arising from its alleged involvement in Bluberi’s financial difficulties (the Retained Claims). The Retained Claims against Callidus were Bluberi’s sole remaining asset and as such the sole security for Callidus’ remaining C$3 million claim.

In 2017, Bluberi filed a court application seeking approval of a C$2 million interim financing credit facility to fund the litigation of the Retained Claim and sought the approval of a C$20 million interim lender super-priority charge in favour of the Funder (Bentham IMF, now Omni Bridgeway). The terms of the litigation funding agreement included a success fee based on a percentage of the litigation proceeds. The expended amounts were otherwise not reimbursable and carried no interest.

A week later, and a day short of the hearing of Bluberi’s application to approve the litigation funding arrangement, Callidus proposed a plan of arrangement, providing for a C$2.63 million payment to Bluberi creditors, except for itself, in exchange for a release from the Retained Claims. The supervising judge adjourned the hearing of both applications. In the meantime, Bluberi filed its own plan of arrangement, which foresaw that proceeds of the Retained Claims, after payment of expenses, would be distributed to the creditors.

After Bluberi’s failure to deposit the necessary funds to cover the expenses related to the presentation of its plan, Callidus’ plan was the sole plan put to the creditors. Bluberi’s second-largest creditor after Callidus voted against Callidus’ plan, thereby preventing the Callidus plan from achieving two-thirds majority approval.

Following the rejection of the Callidus plan, Bluberi’s application to approve its litigation funding arrangement was heard. In response, to that application, Callidus filed a new plan of arrangement, increasing its contribution to other creditors’ recoveries by C$250,000. Callidus further valued its security at nil and requested the supervising judge allow it to exercise its voting rights as unsecured creditor for its C$3 million proof of claim. If allowed to vote on its own revised plan, Callidus would likely achieve the two-thirds majority vote required for approval of its plan of arrangement.

The Superior Court of Québec1

As we previously reported, the Quebec Superior Court approved Bluberi’s litigation funding arrangement, finding that in an insolvency context third party litigation funding arrangements should generally be approved and did not require the creditors’ approval, subject to the following principles:

  • The third party funding agreement must be necessary to provide the plaintiff access to justice that would not otherwise be available to it;
  • The plaintiff’s right to instruct counsel and control the litigation should not be diminished by the third party funding agreement;
  • The third party funding agreement must not compromise or impair the lawyer and client relationship or the lawyer’s duties of confidentiality;
  • The compensation of the third party funder must be fair and reasonable; and
  • The third party funder must undertake to keep confidential any confidential or privileged information.

Of apparent significance was the fact that the Funder charged no fees or interest on the amounts funded, had expended significant resources in assessing the merits of the claim itself and therefore had no collateral interest in unduly drawing out the proceedings for the purpose of earning greater interest amounts or fees. The evidence was that the litigation against Callidus was the only option that may result in recovery for the creditors, other than the revised Callidus plan.

In refusing to submit  Callidus’ plan to a new vote by the creditors, the court  noted that Callidus’ behaviour had been contrary to the “requirements of appropriateness, good faith, and due diligence [that] are baseline considerations that a court should always bear in mind when exercising CCAA authority.” The court observed that Callidus:

  • Initially contested the appropriateness of the CCAA proceedings to prevent Bluberi from pursuing its claim in damages against Callidus;
  • Allowed the company to work on a valuation of the business, then appointing a chief restructuring officer, only to adopt a different position before the Court in an apparent attempt to exhaust financially the company and its principal; and
  • Filed its plan of arrangement, which provided releases from the claims against it, at 3 p.m. the day before the scheduled hearing for the company’s application for approval of its litigation funding arrangement. Callidus was in effect “buying releases from creditors who have no interests in the awarding of such release.”

The Québec Court of Appeal2

In a unanimous decision, the Court of Appeal reversed the supervising judge’s ruling and ordered that a creditors’ meeting be held to allow creditors to vote on the Callidus’ plan or, if Bluberi files a plan consisting of the litigation funding arrangement, to vote on whether to approve the Callidus’ plan or Bluberi’s plan (including the litigation funding arrangement), with Callidus having the right to vote upon either plan.

If upheld, this decision would have had significant implications for litigation funding in an insolvency context in Canada.  In particular, requiring that a litigation funding arrangement be incorporated into a restructuring plan rather than allowing the court to approve such arrangements on a standalone approval motion would be a material impediment to implementing and advancing the funding for claims.  In many cases the funded claims may need to be brought and asserted well before a debtor company can reasonably put a restructuring plan to its creditors and there may be targeted creditors who have personal interests in voting against the plan and seeing the litigation not proceed despite its benefits to the estate.

The Supreme Court of Canada

The Supreme Court focused its attention on two issues: whether the supervising judge erred in (1) barring Callidus from voting on its own plan, and (2) approving the company’s litigation funding arrangement outside of a plan.

Issues on appeal

The Court recognized the primacy of a creditor’s right to vote but subjected it to the supervising judge’s discretion to bar a creditor from voting to circumstances that demand such an outcome. For example, the supervising judge can bar a creditor from voting where the creditor is acting for an improper purpose. 

The Court found that the supervising judge’s authority to bar a creditor from voting rested on s. 11 of the CCAA and the factual determination as to whether the creditor’s conduct in the case frustrated, undermined or ran counter to the objectives of the CCAA and basic fairness that permeates insolvency legislation and practice. 

Given the wide discretion that the supervising judge enjoys, the Court deferred to the lower court’s qualification as to whether the litigation funding arrangement should be approved as interim financing outside of a plan in the case at hand, taking into consideration the text of the CCAA and the remedial objectives of the CCAA more generally. The Court elected not to provide any definitive guidance for lower courts on the conditions for approval of litigation funding agreements, but recognized that the law on such agreements is still evolving and “insofar as third party litigation funding agreements are not per se illegal, there is no principled basis upon which to restrict supervising judges from approving such agreements as interim financing in appropriate cases.”   Therefore, it seems that the factors considered at the lower court in the Bluberi decision remain relevant.

The Court noted that the litigation funding arrangement and the charge in favour of the Funder did not constitute a plan of arrangement and that formal creditor approval of the arrangement in a restructuring plan was therefore not mandated. Concurring with the lower court judge, the Supreme Court of Canada concluded that Callidus should be barred from voting on its proposed new plan. 

Takeaways

As the global economy faces a growing number of reorganizations and liquidations, as well as an unequal and uncertain access to liquidity, the Supreme Court’s decision in Bluberi lends support to the increasingly interventionist role of the CCAA supervising judge, as well as the legitimacy of the use of litigation funding agreements as interim financing. In parallel, the formal recognition of the doctrine of improper purpose in CCAA proceedings is likely to give rise to further scrutiny of stakeholders’ conduct by the courts, particularly in connection with voting on restructuring plans.

 

Footnotes

1   Arrangement relatif à 9354-9186 Québec inc. (Bluberi Gaming Technologies Inc.) -and- Ernst & Young Inc., 2018 QCCS 1040.

2   Arrangement relatif à 9354-9186 Québec inc. (Bluberi Gaming Technologies Inc.), 2019 QCCA 171.



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