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March 19, 2012

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Law Times • march 19, 2012 FOCUS Insolvency litigation considers rights of first-ranking creditors BY JULIUS MELNITZER For Law Times recent decision of the Quebec Court of Appeal in Maisons Marcoux Inc. The case sheds light on Article 2754 O of Quebec's Civil Code, a provision that has received little reported jurisprudential review. The issue arose in the insolvency of Maisons Marcoux, a Quebec homebuilder. The Caisse Desjardins du Centre de la Nouvelle-Beauce had provided the oper- ating capital for the business, some $3.3 million, and had a security interest over all of Maisons Marcoux's assets. Additionally, one project known as the Boisbriand prop- erties was subject to builders' lien claims. Under Quebec law, the liens ranked ahead of Desjardins' conventional charge. After Maisons Marcoux initiated a Companies' Creditors Arrangement Act restructuring in the spring of 2008, Desjardins advanced a further $2.2 million by way of debtor-in-possession financing secured by a court-ordered super-priority charge against all of the company's assets. "Arguably, the idea behind Desjardins' decision to extend DIP financing was to allow Marcoux to complete the houses it was building and preserve the value of same for the ultimate benefit of Desjardins' first- ranking existing security interest," says Luc Morin of Fasken Martineau DuMoulin LLP. But the restructuring wasn't successful, and Ernst & Young Inc., as trustee and receiver, ultimately sold Maisons Marcoux's assets for $5.8 million, of which $1.2 mil- lion came from Boisbriand. The upshot was that the sale proceeds covered the DIP loan of $2.2 million, leaving $3.6 million. But given the totality of all of the claims in the insolvency, that was insufficient to cover the $4.3 million owing on the cumulative remaining value of Desjardins' convention- al charge and the builders' liens. However, in allocating the proceeds, the trustee allotted the reimbursement of the DIP financing only on the assets on which the builders held liens, meaning they wouldn't recover anything from the pro- ceeds of these properties. The upshot was that the DIP financing would gobble up less of the proceeds from the other assets, leav- ing more for Desjardins to recover under its conventional mortgage. The builders objected, relying on Article 2754, which provides that where a first- ranking creditor has security interests over more than one property, the sale proceeds ntario lenders and business- es operating in Quebec and involved as creditors in insol- vencies may be affected by the must be allocated in a way that limits the participation of the first-ranking credit- or in the property over which others have secured interests to the proportion of the overall sale proceeds represented by that property. "As the Court of Appeal saw it, the trustee's allocation was unfair because it did not provide for the rights of the builders," Morin says. Instead, after calculating that the pro- ceeds from the Boisbriand sale repre- sented some 21 per cent of the overall proceeds, the court used Article 2754 and applied just 21 per cent of the sale proceeds from Boisbriand, or some $462,000, to Desjardins' super-priority DIP loan. The upshot was that the build- ers obtained some repayment and Desjardins recovered less on its conven- tional charge than it would have under the original allocation. "Although one could argue that the end result here is fair, the Court of Appeal's interpretation of Article 2754 is open to debate and could lead to some interesting issues in the future," Morin says. In hindsight, however, it appears that it may have been in Desjardins' interest to pursue a different strategy. "If Desjardins had secured its DIP financing only on Boisbriand, the builders would have got nothing and Desjardins would have recovered both the full amount of its DIP financing and the full amount of its conventional charge," says Marie- Eve Gingras of Davies Ward Phillips & Vineberg LLP. However that may be, the decision could affect the process known as marshalling as it is used in Quebec. 'As the Court of Appeal saw it, the trustee's allocation was unfair because it did not provide for the rights of the builders,' says Luc Morin. "It is not uncommon in Quebec that secured creditors at some time before the sale of the assets enter into an agreement assessing their respective rights over the various assets and allocating the sale pro- ceeds pursuant to this assessment," says Morin. "It will be interesting to see what impact Marcoux has on this practice, although one could certainly argue that nothing in the court's decision precludes such convention- al marshalling before the sale is completed." It's also significant that the DIP financing Timminco Continued from page 9 involved a DIP loan and charges created by the court at the outset of a case, does not address aspects of Indalex that are of concern to lenders with security over working capital assets granted by security agreements governed by the Ontario Personal Property Security Act." Under that legislation, a trust arising under the Pension Benefits Act has priority over security, other than purchase- money security interests, in inventory and accounts. In Indalex, the Court of Appeal held that when a company winds up a pen- sion plan, the entirety of any wind-up deficit was subject to that deemed trust. "In order to avoid such a result, lenders have sometimes sought to create a bankruptcy before the distribution of CCAA sale proceeds and courts have held that in a bankruptcy, the deemed trust loses its effectiveness and also its priority," Firman says. "In Indalex, however, the court did not acquiesce to such a transition." What, then, is the upshot? "There remain many aspects of Indalex that would benefit from guidance from the Supreme Court," Firman says. "That would certainly help facilitate commercial lending practices by removing some uncertainty from them." Observers expect the unions to appeal Timminco. "It will be interesting to see whether the Court of Appeal will use Timminco as an opportunity to correct Indalex before the Supreme Court hears the appeal," says a lawyer working on proceedings involving similar issues. LT was authorized in 2008 before amend- ments to the CCAA and the Bankruptcy and Insolvency Act in 2009. The amend- ments included provisions that pro- hibit a secured creditor from using DIP financing in order to secure pre-existing secured indebtedness. "Before the amendments, it was at least debatable that a secured creditor could do so and therefore Desjardins' expectations were not unreasonable," Morin says. Still, even in the post-amendment era, Article 2754 may bear on the precise allocation of proceeds in this situation. Also left open by Marcoux are issues related to the requirement in Article 2754 that the sale of assets must have occurred under judicial authority. "Even though Marcoux's assets were liquidated under two separate methods, with the Boisbriand project sold by the trustee under the BIA and the other assets sold by the receiver, the court held that it could apply Article 2754 because both sales resulted in the liquidation of Marcoux's assets following the bank- ruptcy," says Gingras' colleague Christian Lachance. The result is that Marcoux assimilates the sale of assets by receivers and trustees because both are officers of the court. "However, a sale under judicial author- ity under Quebec civil law has the effect of vesting the property in the buyer free and clear of any existing security interests," Morin notes. "It will be interesting to see whether Marcoux will support an argument that any sale made through a trustee or receiver in a BIA context has the effect of purging the assets sold from any existing security interests." LT PAGE 11 Recruiting? Post your position on GREAT RATES. GREAT REACH. GREAT RESULTS. Contact Sandy Shutt at sandra.shutt@thomsonreuters.com for details. www.lawtimesnews.com Marcoux Appeal of expected

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