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The eye of the storm

Litigation
|Written By Glenn Kauth

In late October, after fighting off lawsuits by suppliers for outstanding bills, forestry company Thunder Bay Fine Papers found itself in court facing a bid to put it into receivership.

The move succeeded, and now receiver Bob Bougie of Deloitte & Touche LLP in Toronto says the next step is to find a buyer for the company, which had been in distress for some time following a series of closures and restarts.

As a forestry company, the northern Ontario mill is likely one of the low-hanging fruit among businesses facing insolvency in the coming months. But lawyers who work in the bankruptcy field expect as the economic environment gets bleaker, an area of law that has been fairly quiet since a string of high-profile cases earlier in the decade will once again heat up. “There haven’t been a lot of large files since Air Canada and Stelco,” says Ashley Taylor, a bankruptcy and insolvency litigator with Stikeman Elliott LLP in Toronto.

As the credit crisis deepens, however, Taylor has begun hearing from weaker companies he had previously expected to go under that now find themselves unable to find new financing. “Companies were able to roll over their debt and keep operating,” he says. “You heard that over and over again. Now, you hear the opposite.

Perhaps more surprising than hardship in the forestry sector was the recent bid for Chapter 11 bankruptcy protection by Circuit City Stores Inc. in the United States. The move also sent the company’s Canadian arm, The Source by Circuit City operator InterTAN Canada Ltd., to seek similar creditor protection here.

For Mike Weinczok, an expert on business restructuring with Cassels Brock & Blackwell LLP in Toronto, the fact the filing came before Christmas was a sign of how dire the retailer’s situation really was since most companies can usually find a way to hang on for what they hope will be a successful holiday season. “If you’ve got a retailer that fell off before Christmas, that was a really bad story,” he says.

Still, Taylor says the prospect of cross-border retailer bankruptcies is one Canadians should get used to even though the local entities are, in many cases, in better shape than their U.S. counterparts. That’s partially due to the fact that seeking protection allows the parent company to sell its Canadian operations free of obligations, he notes. As a result, both Taylor and Weinczok expect a busy season for litigation, particularly in the new year.

But as some lawyers point out, previous recessions have shown the need to adapt and prepare for the downturn, particularly as corporate work dries up. During the recession of the early 1990s, for example, McInnes Cooper managing partner Bernie Miller says his firm shifted its focus to insolvency litigation.

“We saw the benefit of diversification in that when some areas slow down, others pick up,” says Miller, a Moncton lawyer whose firm has offices throughout Atlantic Canada. “We’re glad to be diversified regionally as well because the Newfoundland economy continues to be robust,” he notes, adding that so far Atlantic Canada has largely skirted the downturn.

At Cassels Brock, the firm has formed a 19-lawyer credit response team aiming to get a handle on the financial crunch. With retailers, for example, Weinczok says the team is helping clients prepare for the inevitable pressures from cash-hungry lenders following the holiday season. In some cases, that means starting to look for new sources of financing or finding ways to improve balance sheets in anticipation of the squeeze

Nevertheless, Weinczok says besides the inevitable bankruptcy cases, litigators should also expect to find themselves busy with a wave of shareholder lawsuits. “I think you’re going to see a lot of litigation against directors and officers,” he says. In the mining sector, for example, low prices have already sent distressed companies like Lundin Mining Corp. into the arms of their stronger counterparts. In that case, the buyer, HudBay Minerals Inc., has already seen challenges — as well as a competing proposal — from shareholder Jaguar Financial Corp. “That could well end up in litigation,” says Weinczok.

How successful shareholder lawsuits will be is another question, of course. As Weinczok notes, litigation — or the threat of it — is a common tactic by actors in distress or who are on the hunt for strategic advantage. “Certainly, what people are doing now is [they’re] scouring around looking for opportunities,” he says. One area where that’s likely to be particularly true is class action lawsuits. In the United States, companies have already found themselves the subject of a wave of actions by shareholders who claim they were duped by executives.

In Canada, Siskinds LLP announced recently it had filed a class action on behalf of investors in U.S. insurer American International Group. The lawsuit targeted the company’s disclosures about its credit default swaps, moves the law firm alleges caused massive losses to Canadian investors.

“What I have seen is that litigation is getting busier,” says Neil Finkelstein of Blake Cassels & Graydon LLP. “When money gets tight, people want to get their money, so they sue for it.” But how lucrative lawsuits end up being is another question. “Whether they’ll succeed is a different issue,” he says. “It depends on what management knew or ought to have known. No one knew this was coming.”

Finkelstein, who often defends companies against class action suits, adds that many cases are lawyer-driven. “They get a big headline, and most of them go nowhere,” he says, noting that it has become increasingly common for Canadian class action lawyers to piggyback on lawsuits launched in the United States. “The U.S. counsel are essentially part of the team in the Canadian case.” In the AIG case, however, Siskinds lawyer Dimitri Lascaris says there is no American involvement. “We do our cases independently,” he says.

A key question for business litigators, of course, is the future of the Big Three North American automakers. Where there is consensus, though, is that the demise of any or all of them would spark a wave of insolvencies that would quickly lead to more work for lawyers doing business litigation.

“I think it will have a huge impact,” says Taylor. “The first to go will be all of the suppliers. Each of the suppliers has suppliers. It’s not going to take a lot for them to go under.” The effect, he adds, would be catastrophic as companies begin slashing jobs and production. “I think you’re looking at a deep effect and I think you’re looking at a long-term effect.”

Even in British Columbia, which has little manufacturing compared to Ontario, business litigator Barry Fraser, of Clark Wilson LLP, has begun seeing signs of hard times. “I don’t think I’ve seen people as anxious about financial conditions as we’re seeing today,” says the Vancouver lawyer, who notes that with real estate prices on the ebb, even developers in what until now was one of the country’s hottest markets are finding themselves teetering on bankruptcy as financing dries up. “Where we’re seeing a significant increase in litigation is in debtor-creditor work,” he says. “People are having trouble paying their bills.”

As a result, some developments have come to a halt, and now Fraser expects a recent spike in bankruptcy filings will get worse in the new year as those lenders who have proceeded cautiously over unpaid bills lose patience. “Everyone I’ve talked to has suggested we’re in the eye of the storm at the moment.”

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