The overall financial situation for Target Corp. was relatively positive when it issued its third-quarter results last November. The net earnings before taxes in the first nine months of 2014 for the Minneapolis-based retailer were US$1.5 billion, in a year where it incurred significant financial costs and unfavorable publicity for a large-scale data breach of its credit card and online operations.
The profit totals would have been significantly higher, were it not for the net loss of $627 million during that period from its Canadian stores. The numbers were clearly not good, but the commentary provided by Target in its Securities and Exchange Commission filings was somewhat oblique. “The collective interaction of a broad array of macroeconomic, competitive and consumer behavioral factors, as well as sales mix, makes further precision and analysis of sales metrics infeasible,” said Target about its Canadian operations.
Less than two months later, the parent company decided to “deconsolidate” with its wholly owned subsidiary and Target Canada filed for protection in Ontario Superior Court under the Companies’ Creditors Arrangement Act. The decision resulted in the closure of all 133 stores operated by Target Canada and the layoffs of 17,600 employees. It also sparked questions about the use of what was designed as a restructuring statute by a foreign company to liquidate the operations of its Canadian subsidiary, while the parent company is still a going concern.
Court documents in the ongoing proceeding also reveal it was the summer of 2014 when lawyers for Target in the U.S. first broached the possibility of a Canadian insolvency filing. The issue continued to be discussed internally at the senior level of the parent company and with strategic advisers and lawyers throughout the fall, although in the court documents, Target says liquidation was always just one possible option.
Tracy Sandler, national chairwoman of the insolvency and restructuring group at Osler Hoskin Harcourt LLP and lead counsel for Target Canada in the CCAA proceeding, says the “flexible nature” of the statute “has been very beneficial,” to the stakeholders. “It has facilitated, among other things, the establishment of a significant employee trust to assist the employees in dealing with their loss of employment.” As well, there has been a “value maximizing inventory liquidation process and a robust real property portfolio sale process.”
Anthony Duggan, a University of Toronto law professor and co-author of a text on bankruptcy and insolvency law, says the factual matrix behind the Target filing is still unusual within the traditional context of a CCAA proceeding. “What makes the Target Canada case distinctive is that the applicants had no intention of preserving the debtor’s business — the debtor’s assets are being sold piecemeal and at the end of the process, the company will be gone and so will the business,” says Duggan.
However, in recent years commercial courts have been more willing to allow the CCAA to be used for liquidation and “in terms of protecting stakeholder interests, this type of proceeding may not be much different than a restructuring proceeding,” says Duggan.
The decision of Superior Court Justice Geoffrey Morawetz to approve the CCAA application was not unexpected, suggests Duggan. “The debtor [Target Canada] was clearly insolvent, because the parent company had withdrawn its funding. There was no alternative mechanism available for ensuring an orderly wind-down of the debtor’s business and the CCAA’s language is open-textured enough to allow the statute to be used for this purpose,” says Duggan.
In his initial decision in January, Morawetz, also a co-author of a leading bankruptcy and insolvency text, referred to the “flexibility” of the CCAA and how it allows for more “innovation and creativity” than the “rules-based” approach of the Bankruptcy and Insolvency Act. “The sheer magnitude and complexity of the Target Canada entities business, including the number of stakeholders whose interests are affected, are, in my view, suited to the flexible framework and scope for innovation offered by this ‘skeletal’ legislation,” wrote Morawetz.
While there were amendments to the CCAA in 2009 and Industry Canada is conducting a statutory review of the provisions, it is a framework where judicial discretion is still king. “The amendments added more, but they don’t tell judges how to exercise their discretion,” says Jassmine Girgis, a law professor at the University of Calgary and a member of the board of the Canadian Insolvency Foundation. “It is a discretion that is appropriate,” when it is a complicated liquidation “that is happening relatively quickly,” says Girgis.
While the CCAA was not initially designed for situations such as the Target filing, “the law evolves,” says David Jackson, a Winnipeg lawyer and co-chairman of the Canadian Bar Association’s upcoming national insolvency and restructuring conference. He agrees that liquidation under CCAA is a “sensitive issue,” but in the case of Target, it is probably an appropriate process, says Jackson, a partner at Taylor McCaffrey LLP in Winnipeg. “How else would you do it? There has to be a structured wind-down.” As well, in the case of a subsidiary, “stakeholders should do things to protect themselves,” in advance, to protect against the possibility of a business failure, he says.
Still, there is not a lot of appellate-level authority on the use of the CCAA in a liquidation proceeding.
The Supreme Court of Canada, in the 2010 decision Century Services Inc. v. Canada (Attorney General), described the CCAA as being more responsive to a complex reorganization. “To permit the debtor to continue to carry on business and, where possible, avoid the social and economic costs of liquidating its assets,” wrote then-justice Marie Deschamps. Even though Century Services was not a liquidation case, its broader principles have been adopted by many lower courts in proceedings that are.
While the framework is praised for its “flexibility” the rights of employees are not always given the priority they deserve, suggests Darrell Brown, a partner at Sack Goldblatt Mitchell LLP in Toronto. “CCAA is effectively controlled by the company,” says Brown, who acted for a union client in Indalex, another recent Supreme Court decision stemming from a CCAA proceeding.
In the Target proceeding, its parent company is also the debtor-in-possession lender and offered up to $175 million in credit during the liquidation process, at an annual interest rate of five per cent. The law firm representing laid-off employees was retained by Target to administer the $70-million trust, which works out to about $4,000 per each former employee, during the wind-down period.
Brown says it is appropriate for Target to pay for the employees’ legal representation because it would be difficult for them to organize on their own. Changes should be made though to formally protect everyone’s interests. “Because the company controls the information, it is highly unlikely employees or creditors, can access it early enough” to make the necessary challenges in court during this process, says Brown.
Information about just what was happening within Target and its Canadian subsidiary in the weeks and months leading up to the filing has been an ongoing issue. Materials filed with the court on behalf of Target state that very few individuals knew about the possibility of a CCAA filing before the final decision was made.
The person in charge of merchandising at Target Canada was not informed of the possibility of liquidation until the week before the application was filed. “At no time did TCC or Target Corporation direct any TCC employee to increase (or reduce) inventory levels as a result of possible or contemplated proceedings under the CCAA or BIA or otherwise,” wrote Sandler in a March 16 letter.
An intercompany debt of $1.9 billion related to the leasing arrangements for Target is also a source of contention, in terms of how this claim will be handled by Morawetz.
Lou Brzezinski, who represents some of the Target Canada suppliers, says, “there is no real mechanism to challenge the inter-company debt,” under the CCAA. “That is why Justice Morawetz has given suppliers large examination rights to try to ensure there is a level playing field,” says Brzezinski, a partner at Blaney McMurtry LLP.
He has praise for the way Morawetz has presided over the case, but he too would like changes to the CCAA. “There should be some minimum statutory protection for stakeholders if CCAA is going to be used more for liquidation,” says Brzezinski.
There is nothing unusual about a court being asked to assess a claim related to intercompany debt, says Sandler. “It is very common and appropriate in CCAA proceedings for intercompany claims to be addressed through a transparent court ordered claims process,” she explains.
Meanwhile, as the arguments in Ontario Superior Court continue toward its eventual conclusion, the Canadian experience for Target is a brief, if unsuccessful event in its corporate history.
The loss in 2014 for US$4 billion was offset partially by a $1.6-billion tax benefit. The additional expenses from the wind down in Canada are not expected to be “material” to Target’s future quarterly results it said in SEC filings this spring. And in the three months after Target’s CCAA filing, its share price had increased by just over 10 per cent.