Alternate dispute resolution mechanisms becoming more of a feature in insolvency cases: report

Following lower numbers since pandemic started, insolvency cases creeping up

Alternate dispute resolution mechanisms becoming more of a feature in insolvency cases: report
Natasha MacParland, Davies Ward Phillips & Vineberg

As predicted in earlier reports, the number of insolvencies has increased during the more recent stages of the COVID-19 pandemic, says a new report by Davies Ward Phillips & Vineberg.

However, the report says the cause of these insolvencies is not simply related to the pandemic. Recent decisions of government and lenders to throttle back on the help they had been providing struggling companies during the pandemic has also contributed to the number of insolvencies.

While the overall number of business insolvencies decreased by 11 percent in 2021 compared with 2020 and remains well below 2019 levels, the number of insolvency filings has grown since the summer of 2021.

“In particular, the number of business insolvencies in Q4 2021 increased significantly – by 36.8 percent – over the number in Q3 202,” the report says. The provinces that contributed most to this increase were Nova Scotia, Quebec, Ontario and Saskatchewan.

The report notes that the increase in insolvencies “can be partly explained by the removal of government supports. However, other factors such as inflation, changing consumer behaviour, supply chain disruption, interest rate increases, geopolitics and, more recently, Russia’s invasion of Ukraine and corresponding international economic sanctions will likely contribute to a further upward trajectory in filing numbers.”

Another trend in the insolvency world is the use of alternative dispute resolution mechanisms (ADR) in Canadian and cross-border insolvency situations.

“We increasingly see companies enter insolvency proceedings when mass litigation threatens their ongoing viability,” the report says. “In this context, ADR can play a crucial role. Generally, this occurs when a presiding CCAA judge directs parties to participate in mediation overseen by either another judge or a private neutral person.”

Mediating judges can limit the time demands on the presiding judge while honouring lawyers’ and parties’ interests in a preliminary judicial evaluation of their cases.

“An expected uptick in filings will further challenge thinly stretched insolvency systems,” the report points out, leading to the authors’ prediction that ADR will be used more – in the form of both mediation and arbitration – as a potential tool for addressing judicial resource shortages.

Natasha MacParland, a Davies partner in the firm’s insolvency group, said the use of ADR can be helpful in complicated cases with the involvement of significant litigation. She says that the presiding judge and court system may not have time to deal with these complications, so using mediation or arbitration to sort things out with an appointed mediator or arbitrator can often help the process.

“The court system today doesn’t have the time or resources to spend hours and hours with parties listening and evaluating, discussing and debating,” she says. “Judges are more likely to say to both parties that they have to go back to trying to work something out.”

Overall, formal insolvency activity reached its lowest level in the summer of 2021 before rapidly picking up in the second half of 2021.

For example, business insolvencies decreased by 19.2 percent in Q4 2021 compared with Q4 2019. And the number of business proposals decreased by 40 percent in Q4 2021 compared with Q4 2019. In contrast, however, the total number of business insolvencies in Q4 2021 increased by 9.7 percent compared with Q4 2020

From a geographic perspective, the Q4 spike in insolvencies is primarily the result of an increase in business insolvencies in Nova Scotia, Quebec, Ontario and Saskatchewan.

Individual sectors generally followed overall trends. However, the number of insolvencies in the accommodation and food services sector increased to 130 in Q4 2021, up from 111 in Q4 2019 (and 93 in Q4 2020).

The two sectors that registered the biggest decrease in insolvencies in 2021 were the retail trade and the accommodation and food services sector. Construction, transportation, and warehousing experienced the most significant increase in insolvencies.  

“Retail insolvencies have definitely slowed,” says MacParland, “from the flurry of filings at the beginning to a trickle now. But that just goes help prove my thesis, which is that some of the issues predated the pandemic and weren’t necessarily caused by the pandemic.”

As COVID-19 restrictions were lifted for retail services, travel and indoor dining, their impact on these two sectors slowed down. On the other hand, construction, transportation and warehousing showed the biggest increase in insolvencies, potentially explained by continued supply-chain issues that are likely to be exacerbated by the recent protest activity and the threat of global conflict limiting the flow of goods domestically and internationally.

“While insolvencies are distressing events for owners, investors, creditors and employees, such bankruptcies and restructurings are often a part of any healthy economy,” MacParland says. “There’s constant renewal and redeployment of assets and capital that has to happen. Companies that are not performing well need to be revitalized or incorporated into a healthier organization. The capital used for the revenue-losing or profit-losing organization needs to be redeployed.”

The number of proceedings under the Companies’ Creditors Arrangement Act (CCAA) peaked in Q2 2020 but has declined since then (with a temporary uptick in Q 2021).

Twenty-six CCAA proceedings commenced in 2021, compared with 60 in 2020 and 38 in 2019. The value of liabilities for CCAA filers in 2021 was consistent with the trend in the number of proceedings. The liabilities amounted to $2.78 billion in Q1 2021 before dropping significantly in the next three quarters. The total value of liabilities for CCAA filers also dropped significantly in 2021 – to $4.22 billion from $8.76 billion in 2020 and $9.00 billion in 2019.

The sectors that saw the most CCAA activity include the mining and oil and gas sectors, with eight filings in 2021 and nine the previous year. However, the report notes that these sectors have historically been predominant in CCAA filings.

On the other hand, the retail trade sector experienced a significant decrease in filings, dropping from 12 in 2020 to only two in 2021, as the impact of COVID-19 on business early on in the pandemic took its toll.

A number of CCAA proceedings that started in previous quarters are still ongoing. For example, in the retail sector, clothing store Le Château Inc. is still working through the court system, as is Laurentian University in Sudbury. The report says the latter is an “unprecedented case for a publicly funded Canadian university,” the report says.

As for receiverships, the Davies report notes that the number of such proceedings reached its lowest level in August 2021 but has been showing a “fluctuating but upward trend. However, the volume is still well below the 2019 and 2020 figures.” The provinces that experienced the highest number of receiverships in 2021 were Ontario, Alberta, and British Columbia, consistent with the historical trends.

Notably, the total dollar value of declared assets in receiverships in 2021 decreased significantly compared with 2020 and 2019: $1.37 billion in assets were declared in receiverships in 2021, whereas $4.23 billion and $5.73 billion were declared in 2020 and 2019, respectively.

As for the increasing use of mediation to solve disputes, the report notes that since 1998, at least 14 CCAA proceedings adopted mediation as a part of their process, “and this approach has become increasingly popular.” Examples of CCAA court-made mediation orders in complex proceedings include CannTrust Holdings Inc., Imperial Tobacco Canada and Sears Canada Inc.

The proceedings and mediation results are often confidential, “which is consistent with the efficiency and fairness goals of mediation in the CCAA context.”

The CannTrust example in 2021 stands out. Through a court-appointed mediation led by retired Ontario Court of Appeal Justice Dennis O’Connor, CannTrust and most defendants in class actions pending in the United States and Canada reached a global resolution of the claims asserted against them. The Ontario Superior Court of Justice (Commercial List) approved the proposed settlements with a sanction order entered on July 16, 2021.

One upcoming issue involving mediation in CCAA proceedings involves the insolvency of Northern Pulp. An application has been made to the court for mediation, but the province of Nova Scotia has opposed this application for procedural and substantive reasons, including the timing and role of the proposed mediation.

Another evolving use of ADR is arbitration agreed to during insolvency. For example, in the case of Urbancorp Toronto Management Inc. insolvency proceedings, consensual arbitration was used to adjudicate a complex claim before a retired judge who is now a private arbitrator/mediator and had been the supervising judge in the case before retiring.

Another example is the case of YSL Residences Inc, where arbitration was used to determine key facts in a complex claim that relied heavily on conflicting evidence on the existence (or not) of an oral profit-sharing agreement and its essential terms.

The Supreme Court of Canada recently considered issues related to another aspect of insolvency – the use of s. 15 of the Arbitration Act and the requirement of a court to enforce valid arbitration agreements by staying court proceedings commenced in breach of the agreements.

In Petrowest Corporation v Peace River Hydro Partners, the British Columbia Court of Appeal concluded that s. 15 is not engaged when a receiver has been appointed under the Bankruptcy and Insolvency Act (BIA) and disclaims an arbitration agreement made between the debtor and a counterparty.

This decision was appealed to the SCC and heard in January. From an insolvency perspective, the questions raised during the hearing highlighted two areas of concern: the relationship between a receivership and a bankruptcy and the role of the licensed insolvency trustee versus that of the receiver. It also deals with the relationship between provincial arbitration legislation and federal bankruptcy legislation and the statutory and inherent discretion in each piece of legislation.

Says the Davies report; “The Supreme Court of Canada’s decision in Petrowest will likely prove helpful in navigating the role that one aspect of ADR – arbitration agreed to before the insolvency proceeding – will play in future insolvency proceedings.”

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