Courts may stop creditors from voting on how to settle insolvent companies’ debts, high court finds
In a win for third-party litigation funding, the Supreme Court of Canada has released its reasons in a decision from the bench on January 23 that approved litigation funding allowing an insolvent company to sue one of its creditors.
“This is validation from the Supreme Court,” says Paul Rand, Chief Investment Officer, Canada at Omni Bridgeway. Bentham IMF, which merged with Omni Bridgeway last year, was the litigation funder and an intervenor in the case.
“Litigation funding – when done properly – is an important and viable tool. So, in insolvencies, it gives a big green light to litigation funding in Canada,” Rand says.
The decision in 9354-9186 Québec inc. v. Callidus Capital Corp. marks the first time Canada’s top court has dealt with third-party litigation funding.
“And it says, quite authoritatively, that litigation financing is not per se illegal,” says Jeremy Opolsky, a partner in Torys LLP’s litigation and dispute resolution practice in Toronto.
“It declines to speak in broad generalities about litigation financing in other contexts, especially the class action context, and implies that lower courts are going to continue to evolve and shape the law on this issue.”
The dispute in the case concerned Quebec-based gaming company Bluberi and the debt it owed several creditors, including Callidus Capital, which had given Bluberi a secured loan. If an insolvent entity owes more than $5 million to creditors, the latter have access to the Companies’ Creditors Arrangement Act to arrange repayment under the supervision of a judge. Under the CCAA process, Callidus put forward a plan of arrangement to facilitate the payment of Bluberi’s creditors. The deal stipulated that Bluberi relinquish the right to sue Callidus.
But in the vote on the plan of arrangement, which included Bluberi’s unsecured creditors, Callidus’s plan fell short of the double-majority requirement of the CCAA: a majority of the creditors representing two-thirds of the value owed. Callidus had the option to vote but declined.
Bluberi then undertook a third-party litigation funding agreement to sue Callidus and asked the supervising judge, Quebec Superior Court Justice Jean-François Michaud, to approve the agreement as interim financing. Callidus objected, saying the funding was a plan of arrangement and required a vote from creditors. Callidus put forward a new plan for creditor repayment, but Michaud found the company was acting with “improper purpose,” as it passed on its voting opportunity the first time and was now attempting to override that result.
“What the supervising judge finds is that the interim financing — called DIP financing — of Bentham’s litigation financing agreement is appropriate and what Callidus is seeking to do by seeking another vote and seeking to be able to vote on the plan is really to act with improper purposes, to double-dip to get another chance at approving its plan and to shield itself from the litigation,” says Opolsky.
The Court of Appeal disagreed and overturned the decision. The Court found the funding at issue was “a type of equity investment,” an agreement requiring a vote and that the funder was seeking to cut in line in front of creditors to take a slice of the company, says Opolsky.
In its reasons released May 8, the Supreme Court of Canada found that the Court of Appeal did not afford the appropriate deference to supervising judge Michaud and that, in many cases, litigation funding qualifies as interim financing under the CCAA. The Court found that litigation funding serves the twin purposes of the CCAA: to keep companies in business and to maximize creditor recovery.
“[I]nsofar 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,” wrote Chief Justice Richard Wagner and Justice Michael Moldaver for a unanimous panel of seven judges.
“We acknowledge that this funding differs from more common forms of interim financing that are simply designed to help the debtor ‘keep the lights on’… However, in circumstances like the case at bar, where there is a single litigation asset that could be monetized for the benefit of creditors, the objective of maximizing creditor recovery has taken centre stage. In those circumstances, litigation funding furthers the basic purpose of interim financing: allowing the debtor to realize on the value of its assets.”
The Court added the decision was consistent with lower court decisions, for example, the Ontario Court of Appeal’s decision in Crystallex (Re), 2012 ONCA 404, a case involving an insolvent mining company suing Venezuela and in which the US$3.4 billion arbitration claim was the company’s sole asset. The Court found the facts in Crystallex and in the case at bar were similar.
“This is an insolvency case,” says Rand. “But litigation funding is something that more and more companies are looking at being applicable to them. So in this case, it's David and Goliath, where we're funding an insolvent entity, but increasingly well-capitalized companies are entertaining litigation funding because they're able to use it as a tool to transfer the risk of their litigation and the cost of their litigation onto third-parties’ shoulders.
“And so while I think that this case is about insolvency,” Rand adds, “and it's really going to have the most direct impact on the insolvency space, it being a Supreme Court decision in a commercial matter is going to help, I think, draw more attention to litigation funding as a broader strategy for really any company to consider.”