As government and lender supports fall away, report says insolvencies likely to start rising
Environmental Social and Governance considerations will play an increasingly important role in insolvency proceedings, says a new report by Davies Ward Phillips & Vineberg LLP.
“What we could call ESG has for a long time been considered as part of the insolvency process,” says Davies’ partner Natasha MacParland, one of the co-authors of the report. She notes that “social stakeholders” already play a role in proceedings.” But those concepts will now likely be taken to the next level.
For example, MacParland points to how judges overseeing insolvency proceedings have always considered what the loss of a business will have on the community. “They will always want to minimize the impact on the community, whether it is directly through jobs, or indirectly in terms of what the loss of those jobs would do to the community.”
In one example, MacParland says she was recently involved in a receivership proceeding in New Brunswick where the judge “point blank asked all of us what the impact was on the community.” The judge also said it was important after the close of proceedings to keep a close eye on what happened to suppliers in the community who were creditors who didn’t get paid.
On the governance side of ESG, MacParland points to retention payments for executives receiving more scrutiny, especially in cases where creditors are not being paid back in full.
The report says insolvency and restructuring “will likely be defined by consistent engagement with environmental, social and governance considerations,” and adds that “the risks associated with vulnerable places, systems and assets will become impossible to ignore.”
In particular, MacParland pointed to three global trends involving ESG goals that will also apply to Canadian insolvencies. These include:
- ESG considerations are intensifying in the distressed credit space. Lenders and sponsors are increasingly incorporating ESG factors into investment decisions and considering sustainability and inclusion in their assessments of business plans and valuations during a restructuring
- Industry leaders are turning to improvement on ESG factors to increase valuation and reduce credit spreads. They are also increasingly demanding ESG covenants to address material ESG risks
- Executive compensation after exit is also increasingly linked to ESG goals and benchmarks.
The report says that it is expected Canadian insolvency and restructuring practitioners will play an “important role in guiding the navigation of ESG opportunities in the context of unprecedented uncertainty.”
It adds: “Given the breadth of industries – from higher education to Bitcoin – that have recently had organizations go through an insolvency process, Canadian insolvency and restructuring professionals have earned the confidence of regulators, stakeholders and the general public to address instability, and devise solutions.”
MacParland also notes that many non-financial “stakeholders” have been listed as interested parties in insolvency proceedings. For example, the Canadian Cancer Society has been on the service list of tobacco-related insolvency cases.
On the environmental side, certain obligations in this area must be prioritized. “Once the company is insolvent, and there’s not enough money to pay all the creditors, the question is who suffers?” Stability in the priorities is critical, she adds.
“So, in terms of environmental liability, if there’s already a pre-existing statutory priority for that obligation, then it will get paid. But if not, then it gets to be a more difficult situation, because, lenders have lent into a situation based on their assessment of the risk, which includes what has priority?”
She noted the February 2019 Supreme Court of Canada decision in Orphan Well Association, et al. v. Grant Thornton Limited, et al, which overturned the Alberta Court of Appeal (ABCA) in Orphan Well Association v Grant Thornton Limited. (It is also referred to as the Redwater case.)
In overturning the Alberta Court of Appeal, the SCC ruled that while trustees will not be personally liable for abandonment and reclamation obligations, the estate will remain liable for such obligations. The impact of this decision relates to the relative financial priority between the company’s creditors and the cost to reclaim and abandon the wells.
The SCC went on to order that the proceeds of sale from the active wells should be used to satisfy the reclamation orders, with the result that there be no proceeds available to Redwater's secured and unsecured creditors. Previously, the SCC had held that where a regulator had sought to enforce reclamation obligations prior to bankruptcy proceedings, those obligations were subject to the bankruptcy priority scheme and would not rank ahead of other creditors. However the impact of the decision outside Alberta oil and gas is not yet clear.
Another ESG consideration that will likely be given more importance is dealing with Canada’s First Nations and indigenous peoples. “There is increasing understanding that these considerations have a seat at the table during insolvency proceedings, and if there are environmental issues, even more so.”
In addition to ESG concerns in insolvency cases, the Davies report also anticipates that the fiscal protection being provided over the last two years because of COVID-19 “will fall away as government support scales back and businesses face continued cash shortfalls, mounting debt obligations, altered consumer behaviours and rising interest rates.” This will result in an uptick in restructurings and insolvencies in the coming months and years.
However, the report goes on to say that financial and personal losses caused by the pandemic are “profoundly tragic,” but insolvencies and restructurings, and the laws guiding the process, “have a role to play” in creating a better world.
“Our experience has taught us that transformation is a matter of not only loss, but also opportunity.”