Friday, February 8, 2013

Placing Creditors Ahead of Pensioners?

Last Friday, in a 5-2 decision, the Supreme Court of Canada ruled against pensioners in Indalex case:
The Supreme of Court of Canada has rejected a lower court's decision that the pension plan of restructured company Indalex should be reimbursed before financial backers and other stakeholders get a crack at assets.

The top court handed down its ruling Friday.

Indalex was an aluminum manufacturer that began restructuring proceedings under the Companies' Creditors Arrangement Act (CCAA) in 2009.

At the time, Indalex had two underfunded pension plans, but the United Steelworkers union — on behalf of the employees —had argued that those plans should be replenished before creditors received the proceeds, as has traditionally been the case in insolvencies under Canadian law.

In 2011, the Ontario Court of Appeal ruled on the side of the pensioners. But in a 5-2 decision released Friday, Canada's top court overturned that decision.

"The United Steelworkers appeal should be dismissed," the court said in the ruling.

In the case, Indalex assets were sold to a U.S. company, Sapa Group, after the former ran into some financial difficulty in 2009. While that was happening, the company was ordered to pay back the creditors who had kept it afloat during CCAA proceedings, which moved the company's pensioners and their $6.75 million pension shortfall further down the hierarchy of who would be paid, and how much they would get.

That funding was known as a "debtor-in-possession" loan and is common in insolvencies and restructurings. DIP funding gives companies cash to keep the business going, and those who give them typically do so in part because they are guaranteed to get their money back ahead of other claimants should a dispute arise.

The original court sided with the DIP creditors, until an Ontario Court of Appeal ruling raised legal eyebrows by throwing a wrench into that long-held tradition. It decided the pensioners should take priority because they had formed an entity known as a trust, and should be considered secured creditors.
Precedent-setting case

The Ontario court also ruled that the people overseeing the company had breached their fiduciary duty to the employees by concealing the company's financial difficulties. In the 5-2 split decision, the dissenters on the Supreme Court agreed with that view.

"The employer not only neglected its obligations towards the beneficiaries, but actually took a course of action that was actively inimical to their interests," the court ruled. "The seriousness of these breaches amply justified the decision of the Court of Appeal to impose a constructive trust."

But ultimately, the court's decision largely upheld the status quo on a federal level.

"As a result of the application of the doctrine of federal paramountcy, the [creditors] supersedes the deemed trust," the court said. That's the Supreme Court's way of affirming that no provincial law should be able to supercede the federal legislation for companies that undergo restructuring through the Companies' Creditors Arrangement Act.

The case has implications for any Canadian company with a pension plan, because it reasserts the supremity of existing legislation, which holds that secured lenders always take precedence over other stakeholders when a company sells assets and divests the proceeds during a restructuring.

Business groups were watching the case closely because they saw the Ontario Court of Appeal ruling as a threat in the current economic climate, where restructuring is often a necessity.

"They restored the original order that pension plan members were unsecured creditors," lawyer Brian Rogers, who has no stake in the case, told CBC News. "The pensioners are now back where they were when this all started."

The employees will still receive what they paid into the plan, but they will lose about half of what they would have received under their full pensions.
Jeff Gray of the Globe and Mail also reports, High court ruling places creditors before pensioners:
The Supreme Court of Canada has ruled that the U.S. parent of an insolvent Toronto company is entitled to the Canadian entity’s last $6.75-million, instead of a group of the firm’s retirees, whose pensions were cut after their employer went under.

The court’s ruling in the case of Indalex Ltd., which plunged into bankruptcy protection in 2009, was is expected to have broad implications for other companies and pension plans across the country.

It comes amid widespread concern over the viability of many companies’ pension schemes and public outrage after former employees of Nortel Networks Corp. and other large firms have been left with little after their employers went belly up.

Friday’s decision reverses a controversial 2011 Ontario Court of Appeal ruling that surprised bankruptcy lawyers by siding with Indalex’s retirees, who had fought for a piece of the proceeds from the sale of the company’s assets to restore their pensions, which had been slashed cut by more than half.

While many cheered that Ontario ruling as a breakthrough victory for pensioners, bankruptcy law experts warned the decision would radically reorder Canada’s insolvency regime. They said it could make it more difficult for struggling companies with large defined-benefit pension plans to borrow the money they need to weather financial storms.

Normally, in the scramble for money after a company has filed for bankruptcy protection under the federal Companies’ Creditors Arrangements Act, pension plans rank far below the banks and hedge funds that lend last-ditch money to distressed companies. These “debtor-in-possession” or DIP loans usually come on the condition of a court-ordered guarantee they will be repaid first.

Indalex, an aluminum processor, had a $6.75-million pension shortfall when it entered bankruptcy protection. But all of the cash from the sale of its assets was bound for the company’s U.S. parent, Sun Indalex Finance LLC, to cover some of its costs for paying back DIP loans made to Indalex by a group of banks.

The Ontario Court of Appeal’s 2011 ruling said the money should go to the pensioners because Indalex had breached its duties to its retirees by failing to keep their pension plans fully funded and by failing to give proper notice that it was plunging into bankruptcy protection.

On Friday, Bay Street bankruptcy lawyers welcomed the Supreme Court’s reversal of that decision, saying it restores certainty for DIP lenders. But they also singled out part of the decision as at least a consolation prize for pensioners – and something that could still create concern for those who lend money to companies.

Although it ultimately determined that the DIP lenders rank first because the court orders that grant them priority come under a federal law, the court also surprised observers by ruling the full amount of a pension shortfall at a plan’s windup should be considered a “deemed trust” under Ontario’s pension law. That could push pensioners’ demands further ahead in the line of creditors, but still second to DIP lenders.

A lawyer for Sun Indalex Finance LLC said the company had no comment.

Andrew Hatnay, a Toronto lawyer with Koskie Minsky LLP who acted for former executives with Indalex whose pensions were slashed, said U.S. bankruptcy judges are much more likely to use their discretion in such cases to help employees: “The Supreme Court [of Canada] has gone in the opposite direction … leaving more room for potential abuse of the bankruptcy system.”

Robert Leckie, a former executive with Indalex who lives in San Antonio, Tex., and whose pension was slashed in half, said he was disappointed with the Supreme Court’s decision.

“To allow a pension plan to be underfunded by this amount, it’s an indictment of the whole system, really,” said Mr. Leckie, who recently had a bone marrow transplant to treat his leukemia.

The 65-year-old said he keeps his troubles in perspective: “On the one hand, it is outrageous, and I miss the money and I need the money. On the other hand, I am so aware that there’s so many people both in Canada and in the United States that have been suffering these last few years that are so much worse off than I am.”
The Supreme Court's decision is huge, placing creditors ahead of pensioners but with an important twist. In order to avoid abuse, the decision clearly stipulates that the full amount of a pension shortfall at a plan’s windup should be considered a “deemed trust” under Ontario’s pension law. As the second article states, that could push pensioners’ demands further ahead in the line of creditors, but still second to DIP lenders.

Diane Urquhart sent me an email stating how she thinks the Supreme Court's decision was losing the battle on DIP financing and winning the war on whole pension deficit = deemed trust under PBA, which is considered a trust under CCAA. However, she also told me this decision adversely impacts the disabled employees:
The creditor claims of long term disabled insureds, who are covered by employer sponsored, or self-insured, disability benefit plans, now have a priority that is below Ontario pensioners in CCAA proceedings. The creditor claims of long term disabled insureds in this situation are unsecured creditors, at the bottom of the list of creditors in CCAA proceedings.

Diane added this:
Initial media headlines on the SCC Indalex decision were misdirected at the loss of priority of pension deficits over DIP financing. DIP financing is rightfully super-priority. The war victory was that the whole pension deficit is now defined to be a deemed trust, where trusts are equal to secured creditors under CCAA.

Banks are surprisingly quiet on this. It may be that they expect to convince CCAA judges to put provincial pension deficits’ deemed trusts below secured creditors due to paramountcy of Federal CCAA and CCAA purpose to be the facilitation of a successful restructuring as an ongoing concern. Nonetheless the SCC Indalex decision is a good one, because it forces the CCAA judge to be very attentive to whether a company is actually planning to restructure over is simply conducting a lock stock and barrel sale of its businesses or the company as a whole.

Having said this, in Nortel CCAA case, J. Morwetz always referred to the need for him to facilitate a restructuring of Nortel throughout this case, even though Nortel had announced it was liquidating by June 2009. The pension fund beneficiaries’ court appointed lawyers need to file motions to stop this abusive use of the term restructuring to cover liquidations.
However, these pension fund beneficiaries’ court appointed lawyers are in the bankruptcy lawyers’ cartel and are paid by the corporation sponsors of pension plans. As a consequence, they rarely, if ever, challenge the corporation or judges who mischaracterize what is actually going on in terms of liquidation rather than restructuring.

Why is this decision so important? Because many corporate plans are still reeling after 2012, and if companies falter, pensioners will be vulnerable in bankruptcy proceedings.

Perhaps this is why the CAW is asking its members to approve a request by Chrysler Canada to allow the automaker to make contributions to its underfunded defined benefits pension over 10 years instead of five
“We recommend that the CAW Canada and its membership support the temporary solvency funding relief,” said CAW Local 444 president Dino Chiodo in a letter posted on the union’s website. “Chrysler is a viable corporation. Extending the pension funding period does not put the plan at significant risk.”

In fact, rejecting Chrysler’s request could jeopardize the pension plan, Chiodo warned.

“Without solvency relief, we see the employer coming to the next set of negotiations with demand for converting to defined contribution pension plans.”

Chrysler is among a growing number of employers seeking temporary solvency funding relief under an Ontario government regulation that took effect Nov. 1, 2012.

Under the changes, which apply only to defined benefit pension plans, companies can either consolidate the current solvency payments into one new schedule payable over five years, or fund any new solvency shortfall over 10 years instead of the normal five.

The 2011 was a difficult year for defined benefit pension plans in Canada, the CAW letter noted. “Low interest rates mean poor investment returns on pension plan assets and increase liabilities. The overall funded status of pension plans deteriorated in 2011. The Ontario government estimates that pension solvency levels fell from a median funded level of 87 per cent in 2010 to 72 per cent last year.”

Chrysler has sent letters to CAW members outlining its plans to seeking funding relief, Chiodo said.

Chrysler’s plan warrants the union’s support because the automaker is “a viable corporation. Extending the funding period does not put the plan at significant risk,” Chiodo said.

Also, interest rates are likely to increase in the coming years, which will improve the funding status of pension plans, he said.
As at Jan. 1, 2011, there were 8,807 active plan members, 8,505 retirees, 1,835 surviving spouses or beneficiaries, 1, 045 disabled members and 1,429 terminated vested members, according to Jo-Ann Hannah, director of pensions and benefits at the CAW national office.
Extending the funding period doesn't put the plan at significant risk and interest rates are likely to increase in the coming years, which will improve the funding status of pension plans, but this isn't a strategy I'd want to bet my retirement security on if I was working at any company offering me a defined-benefit plan.

Air Canada is another company struggling to meet its pension obligations. It's now asking the federal government for help:
Air Canada says it has charted a path to sustained profitability after turning in its first annual profit in five years in 2012 - but all of its efforts will be for naught if the country's largest carrier is unable to get a little help from the federal government on its pension funding obligations at the start of next year.

The airline reported Thursday modest net earnings of $53 million, or 19 cents per share, for 2012. Returning to the black is a significant achievement for the airline, which lost roughly $850 million in 2008 before current chief executive Calin Rovinescu embarked on a massive restructuring. But there are plenty of issues Air Canada must still tackle in the year ahead.

"We are mindful that we have much to do to achieve our goal of sustained profitability year after year after year. But as today's results show, we're on the right course," Rovinescu said on a conference call.

The pension funding obligations will be the largest hurdle in front of Air Canada after years of low interest rates and poor equity markets saw its pension solvency deficit balloon to $4.2 billion at the start of 2012.

The airline successfully negotiated a reduced funding schedule for its pension obligations as part of a restructuring in 2009. But that will expire at the end of 2013.

So far, Finance Minister Jim Flaherty has played his cards close to his chest on whether an extension will be granted. The Department of Finance declined to comment on the matter Thursday.

Air Canada's management said it was in the midst of calculating where the solvency deficit sat at the start of 2013, noting that its recently implemented labour agreements should reduce the figure by $1.1 billion, though that won't take effect until Jan. 1, 2014. The company estimated a one percentage point decrease in the discount rate would result in a $1.84-billion reduction to the pension solvency liability, but there has been no indication that it can bank on that.
We'll see what the Finance Minister decides but all I can tell you is what I've been arguing all along on this blog, namely, pension issues will not magically disappear and they will likely get worse.

Importantly, our retirement system is broken and extending funding periods and praying for higher interests rates is not a long-term strategy for bolstering the retirement security of millions of Canadians. There is only one real solution to this pension mess, let companies worry about their business, not pensions, and expand CPP and QPP coverage so that all workers -- public and private -- can retire in dignity and security.

The other solution?  The private sector solution, either banking on PRPPs, just another hyped-up defined-contribution plan, or just letting insurers carve out the pension turkey, leaving retirees receiving annuities vulnerable to low interest rates. When it comes to pensions, we all need a reality check.

Some companies, like BCE, have the cash flow to make their pension contributions and decided against following Verizon on pensions. But most companies are struggling to generate profits and are not in the same position to keep making large pension payments. Remarkably, amidst this slow motion calamity, some actuaries see no problem whatsoever and are even citing five reasons to go slow on C/QPP expansion. What planet do these actuaries live on?!?

Below, Hélène LeBlanc (LaSalle—Émard, NPD), addresses the National Assembly on how the Government of Canada has failed to protect Nortel pensioners like Mrs. Poulin and many others (in French; transcript available here). In that case, pensioners took a back seat to bondholders. The precedent is set, creditors ahead of pensioners but with an important twist.